John Hurley: Recent economic developments in Ireland and the outlook for the
economy
Opening statement by Mr John Hurley, Governor of the Central Bank and Financial Services
Authority of Ireland, at the presentation of the Annual Report 2006, Dublin, 11 July 2007.
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You are all very welcome to this press briefing to mark the publication of the Annual Report
of the Central Bank and Financial Services Authority of Ireland.
I will briefly introduce my colleagues who join me today. Liam Barron, our Director General,
Deputy Director General Brian Halpin, Director General Designate, Tony Grimes, and
Maurice McGuire, Head of Economic Analysis and Research.
As you know, Liam Barron is retiring as Director General next month. At the outset today I
would like to thank Liam for his outstanding contribution to this organisation over a long and
distinguished career, in particular as Director General and as a member of the Board. I would
also like to take this opportunity to wish Tony Grimes all the very best in his new role. Tony is
well placed to bring this organisation forward and to meet the various challenges in the years
ahead.
The Annual Report describes in detail our activities in 2006, which proved to be another busy
year for the Bank, both in terms of our domestic and our euro area responsibilities. Today we
are also publishing our strategic plan for the coming three years.
I should also mention that the annual Financial Stability Report will be published in the
autumn and that the Financial Regulator will publish its own Annual Report later this month.
Economic developments
I will begin by reviewing economic developments in Ireland over the past year or so, before
moving on to discuss the outlook for the economy for this year and next.
The latest CSO National Accounts data, which were released after the Annual Report was
finalised, indicate that the economy performed very well last year with GNP growth of 6.5 per
cent and GDP growth of 5.7 per cent.
Reflecting the strength of output growth, last year was another good year for employment. An
expansion of almost 41⁄2 per cent in the numbers employed brought total employment above
the 2 million mark for the first time. The unemployment rate remained low, below 41⁄2 per cent
- essentially full employment conditions.
The pace of expansion last year was, in fact, somewhat above the economy's medium term
potential and, partly as a result, there was an increase in inflation. The Harmonised Index of
Consumer Prices, which is the most appropriate measure, rose by 2.7 per cent compared
with 2.2 per cent the previous year. The rate of inflation for goods remained broadly in line
with the euro area average but services inflation moved noticeably higher. This undoubtedly
reflected the strength of domestic demand in particular, and occurred in spite of the
significant increase in labour supply through substantial inward migration.
Domestic demand was the main source of output growth. Construction spending was still a
major contributor, although it is clear, in retrospect, that housing completions reached a peak
last year and are declining towards a more sustainable level. Consumption growth also
remained strong in 2006, buoyed up by the continued growth in employment and earnings. In
contrast, export growth was quite muted. The volume of exports of goods and services grew
by just 4.4 per cent, mostly due to trade in services. This implies a decline in Ireland's share
of world trade.
Another feature of last year was the further increase in the current account deficit on the
balance of payments. The latest CSO data indicate that the deficit reached nearly 5 per cent
of GNP last year. This indicates a need to rebalance growth. Some of this rebalancing will
occur, as a matter of course, as the growth in consumer spending is expected to moderate
next year. This is likely to result in reduced import growth. A recovery in export growth is,
however, also required as a part of this rebalancing. In the long run, in a small open
economy like Ireland, continued growth in incomes and employment depends, to a significant
extent, on a satisfactory performance by the traded goods sectors. In this regard, there are
welcome signs of a somewhat improved export performance in the first quarter of this year
but we need to see further data in the coming months before we can be confident that a
sustained improvement is taking place.
Last year was a very good one for the public finances. The strength of growth helped to
boost revenues resulting in a General Government Surplus of 2.9 per cent of GDP, one of
the best performances in the European Union. Some of the strength of revenue, however,
reflected the composition of growth, with construction and the property market contributing
significantly. This factor was taken into account in framing the fiscal forecasts for 2007 in the
context of the last Budget.
There were also important developments in the price of residential property last year. You
may recall, at this time last year, that the Bank was very concerned about the reacceleration
in house prices that had occurred. Current developments are more consistent with stability in
the market. Looking forward, it is important to recall that the major underlying factors
supporting the demand for housing are employment growth, increases in incomes,
demographics and social changes. The prospects for these key factors remain favourable,
even allowing for some moderation in the growth rate of the economy, and we continue to
believe that the most likely scenario is a soft landing for the housing market.
There has also been a welcome deceleration in the rate of growth of credit in the economy,
though it is still at high levels. The rate of growth in overall private sector credit has fallen
from over 30 per cent in June of last year to just under 21 per cent in May of this year. The
rate of increase in mortgage credit growth has also decelerated from a peak of over 28 per
cent in March 2006 to about 20 per cent this May. If this trend continues, the growth rate in
mortgage credit should be substantially lower at the end of the year.
Turning now to the outlook for the economy generally for this year and 2008, the Bank's
current projections are that output growth will moderate, though still remaining strong. Overall
growth this year is expected to be about 5 per cent, in terms of both GDP and GNP. The data
for the early part of this year suggest that growth was probably in excess of these levels but
there are two factors that will act to reduce growth somewhat as the year progresses and into
next year. These are the impact of the gradual decline in house building towards sustainable
levels and a moderation in consumer spending growth. In spite of the deceleration in growth
and a modest rise in unemployment, the projected growth rate for next year, at about 4 per
cent, remains favourable by comparison with other economies with broadly similar level of
incomes. HICP inflation is projected to ease from an average of 23⁄4 per cent this year to
about 21⁄4 per cent next year.
It is, nevertheless, important to discuss some downside risks to the outlook, always bearing
in mind that they are risks rather than forecasts. Some risks reflect factors or events
completely outside the control of domestic policy makers. The most obvious of these, at the
moment, are exchange rate movements and oil price volatility. There is still the risk that there
could be a sharp depreciation of the dollar against the euro as part of a correction
mechanism for persistent global current account imbalances. It is impossible to quantify this
risk but it would be complacent to rule out the possibility of a correction occurring that
involved significant exchange rate movements. Given the openness of the Irish economy,
this would impact on our competitiveness position and highlights the need to keep a focus on
all the various factors that can contribute positively to the economy's competitiveness and its
ability to respond flexibly to adverse developments. The Irish economy is also particularly
exposed to oil price volatility as the country's dependence on imported oil as an energy
source is high by international standards.
There are also some other domestic vulnerabilities. The house building sector, though
currently reducing its output, is still large - as a share of activity - by international standards.
I have already outlined the Bank's view that a gradual decline in output to more sustainable
levels is the most likely outcome, but a sharper than expected contraction in housing output
cannot be completely ruled out, particularly in the event of a greater than anticipated
downturn in the economy that affects employment and incomes. There has also been a
recent deterioration in competitiveness and measures should be taken now to reverse this
trend, in order to avoid a more serious situation emerging in the future. Key elements in this
regard would be to continue policies and behaviour which maximise productivity growth and
limit inflationary pressures, for example, by investing in infrastructure, providing a framework
that fosters R&D and promoting increased levels of competition in the economy. While many
of these measures require action at national level, in practice, productivity improvements
ultimately take place at enterprise level, making it essential for public and private enterprises
to focus on efficiency in their operations in an increasingly globalised environment.
Appropriate pay developments, which take account of productivity trends and the
lowinflation environment of the euro area, are also important. In particular, pay developments in
the more sheltered sectors of the economy should not put pressure on wages and costs in
the economy more generally.
In order to cope with any unanticipated slowdown in the economy, whether from international
or domestic risks, it is important to maximise flexibility in the economy. One element of this is
maintaining a strong fiscal position and thus providing a buffer in the public finances which
will help any adverse developments to be absorbed. This would make it more likely that
remedial fiscal measures could be avoided against a background of somewhat reduced
economic growth and facilitate a quicker rebound in the performance of the economy.
In summary, the outlook for the domestic economy remains favourable. There will be some
deceleration in growth, which will reflect a return to a more sustainable level of housing
output and more moderate consumer spending. The growth rate is still expected to be strong
by international standards, however, as I have indicated, there are some risks to the outlook
that have to be considered in framing policy.
International and euro area economy
Turning to the international background for the Irish economy, developments have remained
broadly favourable. The global economy expanded rapidly in 2006, and while some
moderation is projected this year, global activity is expected to continue to grow strongly.
Economic growth in the euro area increased by 2.7 per cent in 2006, its fastest pace in six
years, and activity has remained robust in the first half of this year. Growth has become
increasingly broad based, with the strength of fixed investment spending particularly
impressive. The conditions are in place for sustained growth over the medium-term, with
domestic demand remaining strong and global growth continuing to provide support for euro
area exports. But downside risks that I have already referred to, relating to potential volatility
in the oil market and the possibility of a disorderly adjustment of global imbalances, are also
relevant.
With regard to euro area price developments, the headline rate of inflation has stabilised at
just under 2 per cent in recent months, but is expected to increase somewhat in the final
quarter of the year. Looking past this short-term volatility and focusing on the policy relevant
medium-term horizon, risks to the outlook for price stability remain on the upside. Against the
backdrop of high capacity utilisation and the rapidly improving labour market, there is the
potential for supply side pressures to emerge, and there is also the risk of further unexpected
increases in oil prices. In order to ensure that these risks to price stability do not materialise
over the medium term, and that inflationary expectations are kept firmly anchored, the
Governing Council will continue to monitor closely all developments. As you know the
Governing Council never pre-commits to a specific course of action.
Activities and financial accounts
The annual report gives a full and detailed account of the Bank's activities. I will just refer
here to our financial accounts. The Bank's profits for 2006 amounted to €110.2 million. After
transfers to reserves and adjustments related to the recognition of the Bank's pension liability
as required under FRS 17, the Bank's surplus income amounted to €98.5 million, which
accrues to the Exchequer. In addition, a total of €39.5 million, in respect of the net proceeds
of coin issued, was also paid to the Exchequer.
Strategic plan
We are also publishing our new three-year Strategic Plan today. The plan sets out the key
challenges facing the Bank over the next three years. These include our role in the
Eurosystem and in the domestic economy, management of investment assets, both on
behalf of the CBFSAI and the ECB, the management of risk and management of resources.
Our Strategic Plan sets out eight high level goals. Individual strategies with specific actions
and timeframes have been established to achieve these goals. The inclusion of specific
actions will allow them be easily included in work plans of departments and performance
objectives of staff.
This concludes my opening remarks. My colleagues and I are now on hand to answer any
questions you may have.