Frosty financial winds expected for winter cast a shadow over budget giveaways – The Irish Times

Finance Department chief economist John McCarthy made what sounded like an offhand remark during Tuesday’s post-budget briefing, suggesting Ireland’s economic outlook hinges on the weather in mainland Europe. .

It did, however, reflect the very real possibility that a severe winter in Europe could trigger further gas shortages and a new round of energy price hikes, an event that will almost certainly push the economy here into a full-blown recession. . As things stand, we will be very close to recording consecutive quarters of negative growth (the technical definition of a recession) anyway.

The ministry’s Budget 2023 Economic and Fiscal Outlook Report projects modified domestic demand (MDD), which measures domestic performance, to contract 2.4% in the third quarter of 2022 before rising again by 1.3 % in the last quarter.

This expansion in the fourth quarter, however, reflects the impact of the 4 billion euros of temporary and one-off measures to support households announced in the budget, most of which come into force in the latter part of the year. They will stimulate consumer spending, the main component of domestic growth.

An unexpected increase in investment linked to multinationals paying for remote work renovation projects would also have pushed the dial. Without these elements, Ireland would have experienced a modest recession in the second half of 2022.

“Budget 2023 comes against the backdrop of an economy that is operating broadly at full employment, but where the near-term outlook has deteriorated significantly,” the ministry’s outlook report said.

This deterioration means that inflation, according to the ministry’s projections, will now average 8.5% this year (it is expected to peak at 10.4% in the last quarter) and more than 7% next year. These were significant revisions from its previous projections. In April, he predicted inflation of 3% for next year.

The ministry also notes that the acceleration in inflation is now far from being just a shock to energy prices. “The more widespread mismatch between demand and supply means that inflationary pressures have widened. For example, the latest data shows that annual price increases for 80% of goods and services in the inflation basket exceed 5%,” the report said.

Despite the significant measures announced in the budget, these levels of price growth will drive down real wages, leading to the biggest drop in living standards here since the financial crisis. Based on current inflation projections, real wages will decline by an average of 4.5 percent this year and 3.1 percent next year.

These numbers may seem abstract and technical, but they translate into households unable to pay their electricity bills or struggling to afford weekly groceries.

Consumers are also facing a series of interest rate hikes from the European Central Bank (ECB), which translate into more expensive mortgages, loans and credit card debt. It will be a financially cold winter regardless of the temperature outside.

“The key question is whether the economy is in line for a period of weaker growth or whether an outright recession is in the offing,” the department’s report said. “While this question is difficult to answer, it is important to recognize that the national economy is in reasonable shape, with few of the imbalances that characterized the situation in the mid-2000s,” he says, noting that household and SME balance sheets are in a “fairly strong position”.

“If it is short-lived, then the energy shock can probably be absorbed without excessive economic fallout,” he concludes.

This uncertainty, combined with a noticeable deterioration in growth prospects internationally, cast a shadow over the government’s €11 billion budget grant. The package, the largest on record outside of the Covid era, appeared to put extra money in most people’s pockets and thwart or at least block opposition claims that the government is not wasn’t doing enough.

One-off measures on family allowances and energy credits represent more than €1,000 for a family of three children. Similarly, the extension of the income tax rate by 20% to cover income up to €40,000 for a single person will lead to an improvement in the net salary of single taxpayers by €640 next year, with pro-rata increases for married couples and those in civil partnerships. There was also a one-time reduction of €1,000 on the contribution fee for third-tier students.

“While the package is large, it is not irresponsible, with surpluses still projected for years to come. In other words, it packs a punch but is sensible,” says Goodbody economist Dermot O ‘Leary.Ireland will still run a budget surplus in 2022 (equivalent to 0.4% of the Central Statistics Office’s bespoke GNI* measure of national income) and 2023 (2.2% of GNI*), even with the big budgetary expenditures.

Dublin will be one of the few governments in Europe to run a budget surplus this year so soon after massive Covid spending.

“Normality has yet to be resumed in fiscal policymaking in Ireland following the Covid madness, with the energy and cost of living crisis necessitating another set of aggressive policies to help households and companies to get through what is likely to be a tough winter,” O said Leary.

Even the Irish Tax Advisory Council, which has been at odds with the government over its spending plans in recent years, gave it qualified approval. “By broadly following the 5% spending rule, the 2023 budget strikes a balance between providing support and avoiding excessively adding to higher inflation,” he said.

The government’s fiscal largesse has a lot to do with corporate tax revenues, which have provided it with a platform for spending it otherwise would not have had. Concern over the concentration risk of having just 10 large companies representing such a large share of the tax base has been (somewhat) mitigated by Finance Minister Paschal Donohoe’s decision to set aside 2 billion euros. this year and 4 billion euros next year in a new reserve fund, launching a long-awaited project to build buffers.

Running this windfall in and out every year is just too dangerous for the treasury. The pot has gotten so big – revenue is expected to be around €21 billion this year and €23 billion in 2023, overtaking VAT as the government’s second largest revenue source – that dancing usual relationship between political pressure to spend and economic incentive to save has been avoided. The government has effectively been able to do both.

That said, the measures announced in the budget were never going to be enough to offset the rise in prices or to protect households from the full extent of the inflationary shock. One-off aids also have a lifespan of just a few months, and there have already been calls and suggestions that the government will need to come back with more measures, particularly when winter heating bills come into effect.

Tánaiste Leo Varadkar played down the prospect of another mini-budget for the new year but did not rule out further intervention, saying the situation would be reviewed in January or February.

Likewise, while the government’s new €1 billion energy aid program for businesses, intended to help businesses cope with the rising cost of energy, has been well received, a survey by the Association of Chartered Certified Accountants and consultancy firm Grant Thornton found that more than two-thirds (68%) of SMEs believe the budget has not done enough to help businesses difficulty surviving this winter.

Nevertheless, Kieran McQuinn of the Economic and Social Research Institute (ESRI) says that “Overall, the impact of the budget should help stabilize (partially) household incomes and provide businesses with some leeway to cope with rising energy costs.

While noting that the size of the budget envelope is likely to fuel some inflationary pressures, he also indicates that “more aid may be needed”. The level of budget inflation (economic orthodoxy says it must be, the question is how much) lingers in the background, perhaps overshadowed by the more pressing needs of struggling households, but the government needs to be careful.

McQuinn notes that the deteriorating geopolitical situation has exacerbated pre-existing inflationary pressures, raising new concerns about European energy security. “Despite this, the national economy is still expected to grow,” he says, noting that the export-oriented ICT and pharmaceutical sectors have been largely unaffected by the global downturns.

However, he warns that in addition to externally determined inflationary problems, the Irish economy is likely to face domestic pressures, particularly against the backdrop of a tight labor market. The unemployment rate was 4.3% in August. Economists estimate that unemployment rates of 4% and below equate to full employment in the Irish economy.

In his post-budget briefing, Donohoe called the new environment of accelerating inflation and higher interest rates a “regime change.”

Rapidly rising public borrowing costs (bond yields) have drawn international attention to the ability of some countries to run up debt, which was not on the agenda in the era of easing quantitative (QE) and zero interest rates. The rapid loss of market confidence in the financial situation of the British government, as evidenced by the collapse in the value of the pound sterling, is a good example of this. Rising UK borrowing needs – necessitated by the new government’s controversial tax-cutting strategy – would not have spooked markets to the same extent or prompted an unforeseen intervention from the International Monetary Fund (IMF) if interest rates had remained unchanged.

Yields on UK 10-year bonds, the government’s implied borrowing costs, rose above 4%, the highest since the 2008 financial crisis, and more than triple the rate of 1.3% at the start of this year.

The yield on Irish 10-year bonds rose to 2.7% from 1.5% a month ago and less than 1% a year ago. Ireland, however, remains in a relatively strong position due to the expected budget surplus this year and next, and large cash balances held by the National Treasury Management Agency (€35 billion).

While the economic outlook here is by no means dire, it is clear that the meteoric growth of recent years and the strong Covid rebound have stalled in the face of the current crisis, which has no clear end in sight. It is also undeniable that the financial pressure on households will get worse before it gets better.

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