Quarterly Bulletin 2024:2 – Policy actions need to be taken to sustainably address the economy’s capacity constraints

• Modified domestic demand is forecast to grow by 2.1 per cent in 2024, 2.5 per cent in 2025 and 2.0 per cent in 2026.
• Headline and core inflation are expected to ease to around 2 per cent over the forecast horizon.
• Addressing housing and other infrastructure constraints is necessary to maintain sustainable growth in living standards.

The Central Bank has today (18 June 2024) published its second Quarterly Bulletin of 2024. On the launch of the Quarterly Bulletin, Robert Kelly, Director of Economics and Statistics said: “The Irish economy is expected to continue to grow at a moderate pace until 2026.  Inflation is returning to sustainable levels as global influences on Irish inflation have eased, but domestic price pressures remain high.  As economic activity is expected to be broadly in-line with its medium-term potential, policy attention needs to more firmly turn to bolstering that potential by addressing capacity constraints and reducing structural vulnerabilities in the economy and public finances.

We are beginning to see a rise in real incomes but risks to the overall growth outlook are judged to be to the downside, and there is uncertainty around the projections in a number of key areas. On the external side, there is the possibility of escalating geopolitical tensions impacting supply chains.  On the domestic side, the outlook for consumer spending is sensitive to potential changes in household savings behaviour, as the realised pick-up in consumption appears weak relative to the rise in incomes.

The outlook for residential construction is an important element for the Modified Domestic Demand (MDD) forecast. While there have been increases in the numbers of housing units completed in recent years, looking ahead there is uncertainty around the timing and scale of future increases.  This has arisen given the implications of pandemic-related delays, rising input costs and supply constraints challenging viability, and in part, the operation of policy initiatives, such as the changing deadlines for the waiver of development levies and water connection fees.  Combined these have contributed to a more uncertain lag from planning permissions to commencements to when housing units are finally completed.”

Growth in MDD picked up in Q1 2024 with renewed growth in machinery and equipment investment by large multinationals. Further increases in residential construction points to a positive outlook for overall modified investment. With improvements in real incomes underpinning consumer spending, overall MDD is forecast to grow at an annual average rate of 2.2 per cent per annum from 2024-26. The drag on goods exports arising from sector-specific issues in the pharma and ICT sectors in 2023 appears to be waning and stronger growth in net exports is anticipated from 2024, aided by a gradually improving external environment.

Labour market conditions are stabilising as the gap between supply and demand narrows.  With the unemployment rate anticipated to remain low, forecast growth in wage rates averaging 4.9 per cent out to 2026 is consistent with domestic price pressures normalising, albeit at levels higher than prior to the pandemic. 

Energy, food and non-energy industrial goods prices, which are determined more by global market conditions, are projected either to rise at a much more moderate pace or to decline.  As a result, both headline and core measures of HICP inflation in Ireland are likely to ease toward and hover around 2 per cent this year and next.

The Irish economy has rebounded well from the economic impact of the pandemic and Russia's invasion of Ukraine. Domestic policy has played its part in this. However, given the overall economic conditions at present it would not be appropriate to continue with an expansionary fiscal stance over the period 2024-2026. A credible fiscal strategy, anchored in compliance with the 5 per cent net expenditure growth benchmark, is necessary to achieve an appropriate fiscal stance and have more resilient public finances. As illustrated in a Signed Article accompanying this Bulletin, a continuation of so-called ‘core’ government expenditure absent compensating tax measures growing at a pace similar to recent years would significantly contribute to overheating risks.  Such a scenario would lead to higher inflation, damaging Ireland's competitiveness and long-term prospects for growth in living standards.

Significant structural vulnerabilities are present in the public finances.  These have the potential to restrict countercyclical fiscal policy to support the economy in the future without a significant rise in government debt. Most notable of these is the concentration risk surrounding corporation tax receipts, with 10 large multi-national firms accounting for 52 per cent of these receipts in 2023, and 10 per cent of total government revenues last year.  This leaves the public finances vulnerable to firm- or sector-specific shocks, while also presenting significant uncertainty as to the eventual effect of reforms to the global framework for corporation tax being concluded through the OECD BEPS process.

Sustainably addressing infrastructure constraints in housing, water, energy and transport should be priorities over the medium-term. Public capital investment alongside structural reforms and initiatives to enhance its efficiency and enable complementary private capital investment needs to play a significant role. With likely additional demands to emerge in the crucial area of housing, it is also important to consider the investment needs to decarbonise the economy in-line with legislated targets.  Estimates suggest such required decarbonisation investment out to 2030 could be 15.7 per cent higher than what is currently envisaged by Government.  Fiscal and wider public policy should actively create the necessary economic capacity to facilitate the rise in investment to meet climate targets, housing and other infrastructural needs over the rest of the decade.  Within the boundaries of the sustainable net 5 per cent rule for growth in public expenditure, growth in public capital expenditure should be prioritised.   

The planned creation of the Future Ireland Fund and the Infrastructure, Climate and Nature Fund with the use of excess corporation tax receipts is welcome. However, they should not be seen as a solution for the challenges and opportunities arising from the demographic and climate transitions, nor the critical housing and related infrastructure gap that exists.

Addressing structural vulnerabilities, maintaining an appropriate fiscal stance and sustainably delivering on the necessary rise in public capital investment in the coming years has to be achieved alongside choices on current spending to maintain or alter existing levels of public services. Measures to broaden the tax base and increase government revenue as a share of national income are increasingly unavoidable.

Previous Quarterly Bulletins are available to view on the Central Bank’s website.