Are Ireland's falling employment figures a harbinger of recession?

Was it another blinking warning light in the cockpit of the Irish economy or merely a statistical anomaly? For the first time in seven years, employment fell in the second quarter of 2019, according to the Central Statistics Office's (CSO) latest Labour Force Survey.

The official data source for the labour market here showed employment, the lense through which we’ve been schooled to see Ireland’s recovery, fell by 20,900 or 0.9 per cent in the three months to June. The slip came on the back 28 consecutive quarters of growth stretching back to 2012 and ranks as the worst quarterly jobs performance since the third quarter of 2011.

The CSO was quick to point out that the quarter-on-quarter fall had more to do with “the unusually high” employment growth seen in the previous quarter rather than a major shift in the underlying trend. Seasonally adjusted employment rose by 48,500 (+2.1 per cent) in the first quarter, one of the largest jumps on record.

Nonetheless several analysts seized upon it as a possible warning sign that things are beginning to slow. They also noted that the annual level of employment growth eased to 2 per cent, its lowest level in several years.

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“While one should not get carried away with one quarter, it does suggest that a combination of slower construction growth, Brexit uncertainty and wider global trade concerns is having some impact on the very open Irish economy,” Goodbody economist Dermot O’Leary said.

Even Minister for Finance Paschal Donohoe, in his reaction, alluded to "a softening in the level of employment".

“A slight softening in the second quarter is in keeping with some of the high frequency economic data and surveys released during this period, as well as global economic developments,” he said.

So what is happening internationally and does it point to an incoming recession?

America

The US, the engine of the world economy, is a reasonable starting point. President Donald Trump inherited a relatively strong economy from his predecessor and gave it a gigantic sugar rush in the form of massive income tax cuts and corporate tax giveaways.

The ensuing jump in growth prompted the US central bank, the Federal Reserve, to hike up interest rates in a bid to cool things down. Higher borrowing costs, the end of the sugar rush, and Trump's tit-for-tat tariff war with China has, however, bid up import costs, leading to a contraction in manufacturing, a key recession indicator. The White House has said it is considering a fresh round of tax cuts to boost the economy, possibly funded by the revenue from tariffs on Chinese goods.

Tensions reached fever pitch earlier this month when yields on 10-year US bonds rose above two-year yields, resulting in an inverted yield curve, the first since 2007. Demand for long-term bonds have increased because US investors fear the economy is slowing so they want to lock a steady return on their money.

This increased demand drives long-term bond prices higher and the yields the government has to pay on them lower. The converse is true for shorter-term debt. Since 1950, all nine major US recessions were preceded by an inversion of this kind.

"An inversion of the yield curve has been an excelling predictor of US recession for the past 50 years so it's recent move should not be ignored," O'Leary said. "It is telling us that we are late cycle in the US economy and this is Ireland's most important investment partner. Indeed, we call Ireland the 51st state in our conversations with clients," he says.

“The timing of any downturn, though, is still open to question and we must remember that US growth is still running at a pretty respectable rate,” O’Leary says.

“With regards to definite signals of a slowdown in Ireland, they are tentative at this stage. The employment data this week showed a fall for the first time in seven years in Q2, but this came after an exceptionally strong figure in Q1. It did indicate that a slowdown has occurred and this is backed up by the survey evidence,” he says.

“We should not be overly surprised by this given the obvious Brexit uncertainties and the fact that Ireland forms part of the global value chain for the largest multinationals in the world, some of which are influenced directly by the US/China tensions,” he says.

“Bottom line is that it is too early to call a downturn in the Irish economy, but it will be largely determined by external events over which we have very little control over,” he says.

Germany

Trade conflicts and weakening global growth have also hit Germany, Europe's largest economy, which, like Ireland, is heavily reliant on global trading conditions. The German economy contracted 0.1 per cent in the second quarter, pushing the economy close to recession, while sentiment surveys and industrial orders data suggest similar conditions are prevailing in the third quarter.

To counter the incoming storm, Germany's finance minister Olaf Scholz is considering a €50 billion fiscal stimulus package, a move that would see Berlin effectively abandon its long-standing policy of balanced-budgeting, such is the fear of another downturn.

With growth and inflation slowing across the euro zone as a whole, the European Central Bank (ECB) is also eyeing a fresh stimulus package, likely to comprise a further cut in deposit rates and more asset purchasing, a year after it had expected to be out the other side of these measures.

Brexit

Closer to home, there is of course Brexit, the harder version of which is expected to cut Irish economic growth to close to zero and result in up to 80,000 fewer jobs in the coming decade. And British prime minister Boris Johnson’s latest manoeuvre to suspend parliament appears to have heightened the prospect of a no-deal outcome on October 31st.

“Brexit is undoubtedly affecting business and consumer sentiment. The related more cautious approach to spending in response to increased uncertainty and pronounced downside risks is clearly in softer trends in large ticket purchases, such as housing and cars, on the part of consumers and flat capital goods imports [for the first five months of the year],” KBC economist Austin Hughes says.

“We are also likely past peak momentum in the Irish growth cycle, reflecting a combination of reduced spare capacity at home and weaker demand growth abroad,” he says.

“There appears to be increased noise in key statistics that likely has little to do with the underlying trend in economic conditions. In this context, GDP growth picked up notably in Q1 to the fastest quarterly pace in five quarters [+2.4 per cent quarter on quarter] after a meagre increase of 0.3 per cent previously.

“There is no obvious reason for a Q1 surge but Q2 data may well show a notably slower pace [particularly if stock-building is reversed]. Similarly, it is difficult to rationalise why Q1 would see the fastest quarterly job gains in 20 years and equally hard to explain why Q2 was the weakest quarter since Q3 2011 for jobs.

“We have to be careful to distinguish between a slowdown – albeit a bumpy one – in Irish economic growth to a more sustainable pace as opposed to a marked deterioration that might be characterised as a material downturn.

“At present, household incomes are growing solidly as employment and wage growth are now rising at a solid pace while spending power is also supported by very low inflation,” he says, while noting that the sterling exchange presents a significant problem.

“Of course, a crash-out Brexit could materially alter these circumstances. We stick to our long-standing view that Irish GDP growth would tumble close to zero in that event, implying an abrupt and painful end to the current growth cycle unless there is a dramatic fiscal policy offset,” he says.

“ If, however, we get some muddle through on Brexit, a still broadly favourable set of fundamentals, including very positive demographics, might mean the Irish growth cycle has several more years to run and we are now seeing a speed-bump rather than the start of a slump,” he says.

One of the key drivers of the slowdown in employment growth in the latest CSO numbers was construction, which appeared to flatline in the second quarter. This is against a backdrop of a Dublin skyline littered with cranes and a significant pick-up in residential housing supply.

Some analysts believe, however, office construction may have reached a peak while the residential building may be slowing on the back of an increase in the amount of unsold stock and a marked slowing in headline inflation.

Precedence tells us two things about economic forecasts: most tend to say the same thing, and nearly all are wrong. Economies are full of surprises and downturns are rarely signposted for policymakers. Who would have predicted the UK would be at full employment and enjoying significant wage growth in the teeth of its biggest economic and political crisis since the second World War?

The Department of Finance’s chief economist John McCarthy spoke recently of the “extraordinarily complex” and uncertain environment surrounding the Irish economy, saying it made forming budgetary policy extremely difficult.

His point was that the Irish economy is now operating at close to full capacity with signs of overheating beginning to emerge but this could rapidly transform into “underheating” as a result of a cyclical downturn internationally, made worse by Brexit and trade tensions between the US and China.

In his recent summer economic statement, Mr Donohoe set out a twin-track approach to the UK’s EU divorce. In the event of an orderly outcome, the Government plans to run a budget surplus of 0.4 per cent.

If a no-deal Brexit happens, the budget will be allowed to move into a deficit, effectively cushioning the economy from the likely trade shock. But he will have to frame the budget before the October 31st deadline, potentially not knowing which way the UK and the European economy will turn and what other lights might start blinking in the cockpit?