With the pandemic waning, 2022 was meant to be the bounce-back year. Agencies and forecasters talked of a resurgence in economic growth with pent-up savings driving consumer demand. Perennially buoyant exports were also forecast to boom on the back of a resumption in global trade. But Russia’s invasion of Ukraine has changed the political and economic landscape, exacerbating already-soaring costs for households and businesses, resulting in a dimmer, more uncertain outlook. Rising inflation and interest rates, potential energy shortages, continuing global supply chain disruptions, a pandemic that refuses to go away, and continuing trade tensions with our nearest neighbour owing to the Northern Ireland protocol are combining to threaten Ireland’s recovery. Never has such optimism unravelled so quickly. Now the talk is whether the global economy will fall into recession; whether Irish households will see a contraction in living standards.
Some say we’re living in the era of the polycrisis, lurching from one emergency to the next, and where multiple, overlapping crises - Covid-19, war, living costs, energy security, climate change - threaten the world order. The cost-of-living crisis erupted ironically just months after the Government ended Covid support schemes which had kept companies and workers afloat during the pandemic. These supports seemed to provide a blueprint for how we might deal with future crises. But war and rising living costs present an entirely different challenge. Chasing inflation - particularly in an untargeted way - can be self-defeating. This is something the Government will have to bear in mind as it comes under greater political pressure to act as household budgets fray. “One thing is for certain, there’ll be a marked slowdown in economic activity and in the pace of recovery from the pandemic,” says KBC Bank Ireland’s chief economist Austin Hughes says. The reduction in real incomes from higher costs will lead to lower consumption growth, he says. The Department of Finance, the Central Bank and the Economic and Social Research Institute (ESRI) have all scaled back their forecasts but none, as yet, are predicting a recession.
Given the vagaries of gross domestic product (GDP) here, Ireland may escape the technical definition of a recession, back-to-back quarters of negative growth, but that may be immaterial. “For many households and businesses, it will talk like a recession and walk like a recession even if statistically it doesn’t squawk like a recession,” Hughes says.
The big question is whether we’re on the cusp of a new inflation paradigm, he says. “There’s uncertainty about whether this is the first sounding of a decade-long surge in price growth,” he says. The head of the Bank for International Settlements Agustín Carstens recently warned that the world is facing a new era of higher inflation and interest rates as deteriorating ties between the West, Russia and China and Covid after-effects drive globalisation into reverse. Soaring global energy and food prices mean almost 60 per cent of developed economies now have year-on-year inflation above 5 per cent, the largest share since the late 1980s, Carstens said. “We need to be open to the possibility that the inflationary environment is changing fundamentally,” he added. Inflation and its sidekick, higher interest rates, are the bogey men of economics. So much of the global economy – stock markets, company earnings, government debt, mortgages – is predicated on their absence.
If companies and workers try and shield themselves from higher costs by putting up prices or demanding higher wages, inflation can get baked into the system. Conversely raising interest rates too aggressively will hurt employment and investment. It’s a difficult balancing act. Deutsche Bank is warning of a major downturn internationally caused by the US Federal Reserve’s quest to snuff out stubbornly high inflation. The problem, according to the bank, is that while inflation may be peaking, it will take a “long time” before it gets back down to the Fed’s goal of 2 per cent. That suggests the central bank will raise interest rates so aggressively that it hurts the economy. Dutch central bank chief Klaas Knot hinted that the European Central Bank (ECB) official may opt to increase interest rates by half a percentage point as soon as July if inflation continues to climb, the first time such an aggressive shift has been mooted. His comments sent ripples through financial markets, triggering an appreciation in the euro and a decline in euro zone bond prices. Markets have priced in 90 basis points of ECB interest rate hikes in 2022, in other words three to four 0.25 per cent increases, but Knot’s comments hint at a more hawkish stance. While interest rate hikes will add to monthly mortgage repayments, at a time of higher energy bills, the assumption is they will be tolerable. However, if rates were to return to more normal levels – 3 per cent, for example – a €250,000 mortgage would be over €400 more expensive each month while a €500,000 mortgage would be €800 extra per month. This could change the dynamic entirely. Ger Brady of Irish employers’ group Ibec says leading indicators like retail sales and card spending suggest the Irish economy had been performing very strongly in the opening months of 2022.
“But rising costs across the global economy, accelerated by the Russian invasion of Ukraine, have put a cap on that economic exuberance,” he says. “Even if inflation growth slows as the year goes on, the level of energy and commodity prices will now remain much higher for longer - this will mean future investment plans are postponed as they are re-evaluated, at the very least,” he says. “The major challenge both business and households will face in 2022 is a transition to a very different type of business environment than the one we have been used to in the past decade,” Brady says. “We are going from a period characterised by very low inflation and all time low interest rates to one where both are going in the opposite direction,” he says.
Nonetheless he plies an optimistic note, suggesting Irish businesses have gotten used to navigating major uncertainty over the past decade - from the financial crisis to Brexit and Covid. “The coming year will be no different, but the business community have proven incredibly resilient in the face of these threats,” Brady says. In the Government’s recent Stability Programme Update (SPU), which sets out its projections for the year ahead, Minister for Finance Paschal Donohoe said the Irish economy was experiencing its third severe economic shock in as many years – Brexit, a global pandemic and now the fall-out from the war in Ukraine. However, he insisted the conflict would “slow, rather than derail the economic recovery”. The upcoming budget in October, when households have felt the full pass-though of higher energy prices, will perhaps be the trickiest of his tenure.
Hughes says fiscal policy must focus on providing targeted supports to businesses and households to prevent “an inflation free for all” - a scenario where the strongest manage to get “inflation-plus outcomes” and the weakest are left high and dry. While there are skills shortage across the board in the labour market, certain categories of workers have more bargaining power than others. “It’s a case of ensuring that there is some element of equalisation, which means tax concessions have to be targeted towards the lower paid to ensure that everyone has some capacity to handle the inflation fallout,” Hughes says, noting this could be done by over-indexing tax bands. A major challenge for Government will be proceeding with the decarbonisation of the Irish economy and the investment in green infrastructure in the face of such a cost-of-living crisis. The Government pushed ahead with its carbon tax in May despite in the face of opposition flak while using offsetting measures - the €200 electricity bill credit, a VAT cut to gas and electricity - to lessen the blow. Another issue, repeatedly highlighted by the Irish Fiscal Advisory Council (Ifac), is age-related spending, more specifically the healthcare and pensions time bomb that’s facing the State and its ageing population.
The pensions commission has made it clear that the current system is not sustainable without considerable reform and has set out recommendations, but the Government continues to put off making the hard decisions. “Ireland’s population is rapidly ageing. A large swell of people born in the 1970s and 1980s will be reaching retirement in the next couple of decades and people are living longer as well,” says Ifac chief economist Eddie Casey. “Last year, the Pensions Commission suggested gradual increases in the pension age and substantial increases in PRSI contributions as one way to address massive funding gaps,” he says.
“But the Government has yet to make a decision on how it will deal with this. Not doing anything would be a major risk to how sustainable the public finances are and delaying things would mean more disruptive changes down the line: bigger tax increases and lower spending,” Casey warns. The outlook for the Irish economy has changed rapidly but most economists are still forecasting growth led by high-pay, high-tax sectors such as IT, finance, and big pharma. The uncertainty factor stemming from Russia’s invasion of Ukraine and from how severe the impact of rising prices, not just here but abroad, will be is huge and that implies a big downside risk to these forecasts.