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QEO Summer 2016

QEO Summer 2016

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Author

Tom McDonnell

Summary

This edition of the NERI’s Quarterly Economic Observer (QEO) outlines our latest expectations for the economic outlook in the Republic of Ireland and Northern Ireland and provides an examination of the public finances, the fiscal rules and fiscal policy in the Republic of Ireland.

The UK electorate’s decision to leave the EU has increased the uncertainty surrounding our economic forecasts. Overall, the impact is highly likely to be negative for both economies on the island of Ireland while the UK itself could fall into recession in late 2016 or early 2017 on the back of declining consumption and investment. The size of the long-term negative economic impact will depend on the outcome of the negotiations between the UK and the EU.

 

Economic Outlook for the Republic of Ireland

  • Internal and external factors will not be as favourable to growth in 2016 as they were in 2015. The impressive 2015 growth figures are unlikely to be replicated.
  • We anticipate the economy will grow at a reasonably robust rate for the duration of the forecast period (2016 to 2018), albeit with growth moderating year-on-year. We project that real GDP will grow at close to 4.6% in 2016 and 3.7% in 2017.
  • GDP growth in 2017 and 2018 will be based on increased domestic demand and will come on the back of further improvements in the labour market, higher levels of private consumption as well as strong growth in private investment.
  • Labour market dynamics should continue to improve throughout 2016 and we are projecting employment growth of 2.6% and an average unemployment rate of 7.8%. The unemployment rate should fall below 7% in early 2018.
  • The strengthening economy will boost the public finances with the deficit falling to around 1% in 2016 and 0.6% in 2017.
  • However, our baseline forecast is subject to a wide range of downside risks. In particular, the precise impact of the Brexit decision on the Irish and EU economies is hard to quantify but likely to be significant.
  • A recession or slump in the UK would negatively impact on Irish exports with consequences for employment and living standards. There is a risk that investment decisions will be postponed or cancelled in the UK. This would affect the UK’s potential output with knock-on consequence for the potential growth rate of Irish exports.
  • A further appreciation in the value of the euro against Sterling or an appreciation against the US dollar would damage Irish exports. The Republic would be particularly adversely affected by such a development given its openness to international trade.
  • The introduction of trade barriers would reduce economy-wide efficiency and damage the potential for medium-term productivity growth.

 

Outlook for Northern Ireland and the United Kingdom

  • The outlook for Northern Ireland economy has weakened given the result of the UK Brexit referendum and negative implications for trade and investment.
  • Private sector spending is likely to slow if not decline in the second half of 2016.
  • The main long-term impact on output in the UK may well come from the changed trade relationship with the EU. This is likely to generate a negative ‘level effect’ that permanently reduces income levels but does not affect long-term growth levels.
  • The long-run potential growth rate will fall if there is a negative impact on investment levels or an exodus of human capital. The Brexit decision is likely to do some damage to the UK’s financial services sector and there is potential for capital flight.
  • The prospects for the Northern Ireland economy in the short to medium term will be dominated by the negotiations for the UK’s exit from the European Union. In the very near term the uncertainty that surrounds these negotiations is likely to have a substantial impact on investment decisions by both domestic firms and potential international investors.

 

Public Finances, Fiscal Rules and Fiscal Policy in the Republic of Ireland

  • On a no policy change basis, the Republic will have one of the lowest public spending-to-GDP ratios in the entire EU by 2021, and a historically low spending ratio by modern Irish standards.
  • Such a low level of spending has significant negative implications for the future provision and quality of public services and infrastructure, and has implications for the future sufficiency of welfare payments. 
  • Adherence to the fiscal rules limits the fiscal space for new commitments to a little over €900 million in 2017. The net fiscal space available in each of 2019-2021 will be close to €3 billion per annum with cumulative unused fiscal space of at least €11.3 billion and possibly as much as €12.7 billion out to 2021.
  • Accommodating demographic and inflationary pressures on public spending will absorb much of the unused fiscal space available between 2017 and 2021.
  • Bottlenecks and infrastructure deficits are already apparent in a number of areas including housing, transport and communications infrastructure. Failure to invest sufficiently in education, national innovative capacity, and infrastructure will constrain the long-term growth of the Irish economy.
  • In addition, an increase in transfer payments will be required in Budget 2017 to cover cost of living increases.
  • Give the above analysis it is our view that there is no room for tax cuts in Budget 2017.

 

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