Domestic recovery now well in train – Investec

Since the start of the year the Irish economy has built on the progress made during 2013. The domestic economy has been a particular driver, although net exports remain an integral part of the overall growth story.

The broad nature of the recovery is reflected in the fact that the three Irish PMIs – Services, Manufacturing and Construction – have been simultaneously above 50 since September 2013.

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The labour market, retail sales and Exchequer Returns data all reflect the improving health of the domestic economy. The economy has added jobs for six successive quarters. The consumer has made a comeback, with retail sales posting eight successive months of annual gains in both volume and value terms, led by ‘big ticket’ items. Tax revenues are rising while expenditure, on the whole, is contained, which reduces the quantum of incremental fiscal consolidation needed to achieve deficit targets. Helped by the resolution of IBRC and the achievement of a positive primary balance, general government debt / GDP should improve to 117.1% by year-end from 123.3% at end-2013. In the property market, the recovery in residential prices has spread beyond the capital and while transactions and commencements are improving, these remain well below normal levels. In the non-residential segment, busy secondary market activity has been supported by positive trends in pricing and rents.

Brighter prospects for Ireland’s key export markets and favourable currency moves provide a tailwind for Irish exporters. The impact of the ‘patent cliff’ on merchandise exports seems to be easing, with industrial production and import data pointing to an upturn for the pharmaceutical sector. Elsewhere, the New Export Orders component of the Investec Services PMI suggests another good year for exports in that area.

In the bond market, buoyed by supportive fundamental (such as those outlined above) and technical (ratings agency upgrades, prudent secondary market interventions by the NTMA) factors, Irish yields have continued to tighten in the year to date. Notwithstanding the current uncertain market backdrop, we see them converging further towards the core by year-end, as Ireland continues to decouple from other peripheral countries.

In all, Ireland continues to move forward. GDP will rise for a second successive year in 2014 with further growth seen in 2015. While headline figures can be distorted by the multinationals, we are particularly encouraged by the rising numbers at work and favourable Exchequer trends, which better illustrate the domestic recovery. With that said, a number of challenges remain, chiefly the need for deleveraging in some areas and the worrisome issue of long-term unemployment. Vigilance is required to ensure that Ireland maintains the above progress.

Labour Market

The Irish labour market continues to exhibit very positive signs, with total employment on the rise, the unemployment rate falling to its lowest level in five years and surveys of employers’ intentions suggesting that this momentum is set to continue into 2015 at least. Notwithstanding this progress, unemployment is still very elevated in absolute terms and within that we note that the proportion which is classified as long-term unemployed is worryingly high.

The CSO’s Q1 2014 QNHS revealed that total employment grew by 0.1% q/q, making it six successive quarters of sequential growth. Total employment has now increased by 3.8% since the trough.

Within the data, we see that the areas that have seen the strongest growth since the Q3 2012 trough are: Agriculture, Forestry & Fishing; Accommodation & Food Service; Professional, Scientific & Technical; ICT; Industry; and Construction.

The CSO has said that “particular caution is warranted in the interpretation of the trend” in agriculture employment at this time, given that “estimates of employment in this sector have shown to be sensitive to sample changes”. Nonetheless, we believe that the numbers at work in this area have seen an improvement, driven by factors such as the imminent removal of EU milk quotas. Indeed, in an update in July the largest lender to the Irish economy, Bank of Ireland, said: “The Agri sector in particular has been performing strongly as it prepares for the abolition of milk quotas in April of next year. The Bank has seen a steady increase in both applications and approvals from this sector”.

The Accommodation and Food sector has benefited from the lower VAT rate on hospitality first introduced in the government’s Jobs Initiative in May 2011 along with the improving signs from the domestic economy and upturn in tourism. A March 2014 report (‘Room to grow’) from accountants PwC on 18 European ‘gateway cities’ predicted that Dublin would see the highest (5.2%) RevPAR growth in 2014, with further growth of 3.8% forecast for 2015. Elsewhere, the latest ‘Overseas Travel’ release from the CSO shows that overseas trips to Ireland increased by 10.3% y/y in H1 2014, and while this is undoubtedly flattered by increased numbers of transfer passengers using enhanced transatlantic connections from Irish airports, we note that the number of nights spent in Ireland by overseas travellers was +5.3% y/y in Q1 2014 (Q2 data have yet to be released).

Taken together, the increase in Professional, Scientific & Technical and ICT employment likely reflects the strong growth being experienced by new and existing firms in the wider technology sector in Ireland. The Industry segment of the QNHS covers a wide range of companies, from mining to medicines, and we suspect that staffing levels have increased across many of the segments covered by these NACE classifications, given the generally positive Industrial Production readings in the year to date across both the ‘Modern’ and ‘Traditional’ sectors.

The rise in Construction employment shown by the QNHS chimes with industry surveys such as the employment component of the Ulster Bank Construction PMI.

In terms of the sectors where total employment remains below Q3 2012 levels, the contraction in Public Administration & Defence reflects tight public budgets, the decline in the numbers working in Finance, Insurance & Real Estate Activities likely reflects cost-cutting by the banks and the fall in the ‘Other’ category (which includes the Arts, Entertainment and Recreation) may also be influenced by constraints on government expenditure.

The seasonally adjusted ‘official’ unemployment rate, as per the Q1 2014 QNHS, stood at 12.0%, down 20bps q/q and 310bps below the Q1 2012 peak of 15.1%. The standardised unemployment rate derived from the monthly Live Register was 11.5% in July (a level last seen in April 2009), which implies that the ‘official’ rate should continue to record improvements as the year goes on.

The number of people signed on the Live Register has declined in each of the past 25 months for which we have data, with July’s total (382,800) some 66,100 or 15% below peak (August 2011) levels. While some of this reduction is due to emigration – we note that the ratio of over-25 year olds to under-25 year olds on the Live Register has continued to widen from the 5.44:1 at end-2013 to 5.75:1 in July – and those returning to education (this is partly reflected in the participation rate, which at 60.2% in Q1 2014 remains some way off its Q4 2007 peak of 64.1%), the return to growth in net job creation in the economy is clearly playing a significant role in reducing the unemployment rate.

One of the most serious issues in the labour market is long-term unemployment. Some 46.6% of those on the Live Register in July of this year had been on it for one year or more. Tackling this issue remains a major priority for policymakers. In this regard, we note that the number of people enrolled on activation programmes, which are targeted primarily at the long-term unemployed and other welfare recipients, stood at 65,709 in June 2014, down 855 (-1.3%) y/y. Persons on activation programmes are not counted as part of the Live Register.

The employment component of all three PMIs for Ireland – the Manufacturing and Services PMIs produced by Investec and the Construction PMI produced by Ulster Bank – suggest that the positive momentum in total employment is set to continue over the rest of the year at least. The employment component of the Manufacturing PMI has been above the 50 no-change line for 14 successive months (to July 2014), while the same component of the Services PMI has been consistently above 50 for 23 consecutive months. The employment component of the Construction PMI rose to just over 50 in September 2013, snapping an unbroken sequence of declines in staffing levels stretching back to May 2007. It has remained above 50 since then – a welcome trend in an industry where total employment remains 63% below peak levels (in Q1 2014 employment in this sector was 6% above the trough reached in Q1 2013).

Apart from rising employment, we expect the coming quarters to also bring further increases in average earnings following years of pay restraint. There have already been signs of this in a number of sectors. Average economy-wide weekly earnings rose 1.1% q/q (-0.4% y/y) in Q1 2014 to €689.88, but we note that there were wide variances within the various sectors. Of the 13 sectors, seven were higher on a y/y basis while six were lower. The areas seeing the largest y/y increases during Q1 2014 were Construction (+10.2%), Accommodation & Food Service (+5.5%) and Industry (+4.3%), while Health & Welfare (-2.3%), Arts (-2.4%) and Education (-2.7%) were the steepest fallers – not a surprise given the factors outlined above.

Last year saw total employment in the Irish economy grow (+2.4% y/y) for the first time in six years. We expect this year to see a similar pick-up (+2.4% y/y) as the recovery continues. Positive readings for the employment components of all three Irish PMIs provide reassurance in this regard. In addition to the higher numbers at work, increased earnings will have a knock-on impact for a number of other areas, such as consumer spending.


Residential property prices continue to improve, with Dublin leading the way but the recovery in prices outside of the capital has begun to harden. Notwithstanding the increase in prices, rental yields remain well above the cost of funding. Completions activity remains quite muted, with lead indicators suggesting that no change is likely in the short term. In the commercial property space, the accelerated wind-down of NAMA and non-core deleveraging by the banks will create further opportunities for the likes of the REITs.

Since troughing 51% below peak (September 2007) levels in March 2013, national residential prices have since recovered by 15%, standing 43% below peak in June 2014.

Dublin residential prices were +23.9% y/y in June 2014, the 11th successive month of double-digit gains on a y/y basis. In the same month, prices outside of the capital were up by a relatively more modest 3.4% y/y (a sixth successive month of growth on a y/y basis). Since the trough in national prices, Dublin prices have recovered by 30.2% while prices elsewhere are +5.6% over the same period.

The outperformance of prices in the capital reflects much tighter supply dynamics (Census 2011 data show that the then Dublin underlying vacancy rate, at 8.1%, was the third lowest of the 26 counties in the State) along with superior economic fundamentals (CSO data show that three out of every five additional jobs created over the past year were in Dublin, which was home to c. 28% of the population at the time of the last Census). As we outlined in our residential property note (‘Irish Housing: From Stabilisation to Recovery’) earlier this year, estimates of new household formation out to 2030 range from 19k to 32k per annum, depending on the net migration assumptions used. In 2013 only 8,301 units were completed, which equates to 24% of the average annual completions going back to 1970 (34,966 units) and between 26% and 44% of the underlying demand for units, depending on the assumption of new household formation used. The early indications are that the outturn for this year will be broadly similar, with Q1 2014 completions at 2,090 units (a quarter of last year’s total). So, completions remain at unsustainably low levels.

Of course, some of the gap between construction industry output and the demand for houses can and will be met through the completion of ‘ghost estates’. Department of Environment (DoE) data show that in October 2013 there were 6,370 ‘complete and vacant’ units, with a further 6,444 ‘near complete’ units, across the 1,258 unfinished housing developments that were awaiting resolution at that time. Assuming all of the ‘near complete’ units are finished (note, however, that some may have been occupied since the DoE survey was conducted), the combined implied supply from these unfinished developments would only satisfy between five and eight month’s new household formation.

So, with new build activity running well below the underlying level of demand for residential property and the economic recovery gaining traction, it appears that the path of least resistance for prices is higher. We are raising our estimates for national house price inflation in 2014 from the previous 6% to 10%.

Another consideration is the issue of mortgage credit. Last year c. 55% of transactions did not involve a mortgage and the early indications are that this year will see a broadly similar outturn. Mortgage drawdowns data from the IBF show that there were 7,463 mortgages for house purchase with a total value of €1.3bn drawn down in H1 2014, which equates to just 47% of the 15,435 residential transactions for the same period that had been notified to the Property Services Regulatory Authority by August 11.

Mortgage approvals (a lead indicator for drawdowns) data suggest that lending activity should increase as the year goes on. In June 2014 there were 2,102 mortgages for house purchase approved (on a three month moving average basis) with a total value of €390m, both of which represent record monthly outturns since the series began in January 2011.

The latest (Q1 2014) Residential Mortgage Arrears and Repossessions data from the Central Bank of Ireland show some encouraging trends on arrears in the PDH (principal dwelling houses / owner-occupied) segment, although the BTL (buy-to-let) area remains more challenging.

At the end of March 2014 there were 762,454 PDH mortgages with a balance of €106.5bn outstanding. Of these, 132,217 were in arrears with a total balance outstanding of €23.7bn, down 4,341 and €727m respectively over the quarter (a third successive quarterly decline in both volume and value terms). Within those, 93,106 mortgages (12.2% of the total) with a total balance of €17.7bn (16.6%) were in arrears of greater than 90 days. The peak in arrears greater than 90 days by value was €18.8bn (17.3%) in Q3 2013.

Also at the end of March 2014 there were 144,686 BTL mortgages in issue, with a total balance outstanding of €29.4bn. Total arrears cases declined during Q4 2013 in both volume and value terms, but as shown above the upward trend resumed in Q1 in both volume (111 additional cases) and value (outstanding balance of €1.1m) terms. While marginal, this is nonetheless somewhat surprising given the improving trends in both residential rents (shown above) and the labour market, although we note that the incidence of early arrears cases continued to decline (for a fourth successive quarter) in Q1 2014. In any event, our view is that arrears have peaked in the BTL segment.

The Department of Finance’s (DoF) monthly Mortgage Restructures Data reports provide timely updates on the banks’ efforts to address troubled mortgages. In May 2014 banks and borrowers had agreed to 69,306 permanent PDH restructures, up from 65,698 in the previous month and 41,236 when the series began (August 2013). Within these, we see that arrears capitalisation (29.5% of all permanent restructures), split mortgages (18.6%) and hybrid/other solutions (15.9%) continue to grow in frequency of use, while previously favoured solutions such as transitioning borrowers to interest only (from 8.0% of all permanent restructures in August 2013 to 1.7% in May 2014) and term extensions (from 34.5% to 21.3% over the same period) are on the wane.

Turning to the BTL segment, the DoF’s data show that 13,434 permanent restructures had been agreed by the end of May 2014, up from 13,096 in the previous month and 9,806 when this series began (September 2013). Similar to the PDH segment, we note an increasing propensity on the part of banks to implement arrears capitalisation, split and hybrid/other solutions in recent months. In terms of measures to enforce their collateral, by May 2014 the banks had appointed 4,378 rent receivers.

All in all, while progress on addressing troubled mortgages is a little slower in the BTL segment than we would like to see, it is reassuring to note that, in aggregate, the Irish mortgage arrears problem is continuing to gradually reduce from elevated levels.

In the non-residential space, we note improving trends in pricing across the office, retail and industrial segments, although the pace at which they are recovering is far from uniform. Office leads the way, followed by retail and industrial in that order. Across those segments, IPD data show that capital values have increased by 24%, 11% and 2% respectively from the trough, but are still 56%, 69% and 63% below their respective peaks.

Prepared by Philip O’Sullivan at Investec | +353 1 421 0496