Will Ireland’s technical recession morph into a real one?

In Ireland, it can sometimes feel like a recession when it isn’t or when the headline statistics say otherwise. Equally, we can – and have – sailed through actual recessions without really noticing them.

The “R” word has become problematic. You’ll see the term “technical” placed in front of it more often than not these days, signifying the textbook definitions are no longer fit for purpose.

The problem of course is GDP (gross domestic product), the standard measure of economic growth internationally, which has become divorced from domestic economic conditions because of multinationals and their gigantic balance sheets.

In the final last quarter of 2022 and the first quarter of this year, the Irish economy contracted on the back of a fall-off in pharma exports, meeting the technical definition of a recession, which is back-to-back quarters of negative growth. Domestically, however, conditions didn’t deteriorate.

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We had an ongoing cost-of-living squeeze and a spate of tech job losses, driven by international forces, but we also had full employment, robust consumer spending and a Government exchequer awash with tax receipts. Not exactly the data points you’d expect to see in a recession.

Ireland’s export-led, multinational-dominated economy has ridden the crest of the globalisation wave, hitting record levels of employment and generating wealth, public and private, that make 1980s Ireland look like a developing country.

The recent sea-change in global demand conditions predicated on a rapid and sudden monetary tightening, geopolitical tensions and the dithering performance of the Chinese economy now pose a challenge, possibly even a check on the globalisation project itself.

But will the slowdown be shallow and short as the optimists maintain or will it morph into something more severe?

The latest euro zone growth numbers pointed to a contraction of 0.1 per cent across the bloc in the third quarter fuelled by a weaker German economy and a bigger-than-expected contraction here (Ireland had the biggest fall in GDP of any country). Another contraction in the fourth quarter and the euro zone will – officially – be in recession.

[ Euro zone inflation falls but economy contracts ]

While the figures weren’t healthy, they weren’t atrocious either, leaving, as one commentator said, “space for pessimists and optimists to see what they want to see”.

Weakening conditions internationally are coinciding with a tick-up in unemployment here and a general softening of the labour market albeit from a position of strength.

According to the Central Statistics Office (CSO), headline unemployment in the Irish economy rose for a third consecutive month in October.

[ Unemployment rises for third consecutive month as Irish labour market softens ]

AIB’s latest purchasing managers’ index for the employment-heavy services sector, which covers everything from hotels and hairdressers to IT firms and telecoms, also pointed to the “weakest rises in jobs and new work for over two-and-a-half years”.

A third indicator comes via corporation tax, which has been running below trend for three months. Receipts from the business tax in October were €1 billion (45 per cent) below the level in the same month last year, the latest exchequer returns show. A weak November, the biggest month for corporation tax, will have a significant impact on the expected full-year budget surplus.

“The end-October exchequer returns present a mixed picture of our public finances. While income tax and VAT remain steady, demonstrating the underlying strength of our economy, we have now seen corporation tax decline for a third consecutive month,” Minister for Finance Michael McGrath said.

What these indicators tell us is that domestic and global conditions have weakened which is hardly surprising in the context of monetary tightening.

At the moment, we appear to be in the shadow boxing phase of the slowdown where multinational exports are being hit (the fall-off in demand for vaccines after the pandemic is also a factor for companies here) but domestically jobs and wages are still relatively insulated.

Markets appear to be pricing in a soft landing with higher interest rates containing inflation without causing a major economic reversal.

“This optimism creates two problems: relatively easy financial conditions could continue to fuel inflation and rates can tighten sharply if adverse shocks occur – such as an escalation of the war in Ukraine or an intensification of stress in the Chinese property market,” the International Monetary Fund said in a recent blog.

But what if markets are wrong and the full impact of monetary tightening is worse than anticipated? It’s been a long time since the bogeymen of inflation and interest rates stalked the global economy.

As the Department of Finance notes “monetary policy acts in a slow-burner manner: it works its way through to real economic activity with a lag”.

The delayed impact of higher interest rates has already prompted the department and others to cut their growth projections for the Irish economy for next year.

In the lead-up to the budget, McGrath sounded a number ofwarnings about the potential for Ireland’s financial position to change while his department highlighted three significant headwinds facing the economy: the slowdown in the EU, British and US economies (the State’s main export markets); the prospect that inflation proves stickier than anticipated; and the corrosive effects of tighter monetary policy.

Was this designed to deflect calls on the public purse at budget time – as most commentators contended – or perhaps reflective of the changing economic circumstances? The duration and uncertain impact of higher interest rates is perhaps the biggest economic question in the world right now.

The risk would be if the euro zone economy flatlines while inflationary pressures and higher interest rates remain, a scenario that could trigger a prolonged stagnation.