Investor: Employment figures released recently by the Central Statistics Office (CSO) support the view that the economy can maintain annual economic growth in the 5 per cent range for some time.

Employment growth continued to strengthen in the second quarter and, in fact, was running at its fastest pace in five years. If anything, these figures could well lead to upward revisions to current GDP growth forecasts.

Total employment in the second quarter was nearly 94,000 higher than the same period of 2004 and the total employment level is now approximately two million. Again, the construction sector contributed most to growth, with an extra 36,900 workers compared to the second quarter of 2004, a rise of 17.6 per cent.

Public services and financial services also recorded strong growth in employment. The long-term trend of declining employment in manufacturing and agriculture continued, with numbers at work falling by 6,600 and 3,400, respectively.

With the unemployment rate stable at 4.3 per cent, close to a full employment rate, the employment boom was once again fuelled by net immigration.

In the year to April 2005, the CSO estimates net inward migration at 53,400. This consisted of 70,000 immigrants (up 20,000 on the previous year) and 16,600 returning emigrants (2,000 lower than a year earlier). If these trends continue, it would seem that the economy is set for a further period of growth far above the European average.

This economic news should be good for the quoted financial sector, which derives a high proportion of revenues and profits from the economy. However, the share price performance of the larger Irish banks has been lacklustre in recent months.

Over the past month, the share prices of the two large clearers - AIB and Bank of Ireland - have fallen, although Irish Life and Permanent and Anglo Irish Bank have eked out small gains. Taken as a group, the year-to-date share price performance of the financial sector is reasonable.

AIB is up 14 per cent, Irish Life & Permanent has risen by 8 per cent, while Bank of Ireland is lagging with a rise of just 4 per cent. Continuing the pattern of recent years, Anglo Irish leads yet again with a year-to-date rise of approximately 22 per cent. With the exception of the Anglo share price gain, these are modest rises in the context of the ongoing boom in the economy.

Some of this recent underperformance can be explained by weakness in the UK bank sector. Despite Ireland being part of the euro zone, investor sentiment towards the Irish banks is still influenced by developments in the UK quoted bank sector. The slowdowns in the UK housing market and in consumer spending are the main cause of this share price weakness.

As an indication, over the past three months Royal Bank of Scotland's (RBoS) share price has declined by 4 per cent and the overall UK bank sector has underperformed the broad European sector by approximately 8 per cent in recent months. Since late July, the two large Irish banks have underperformed the European bank sector average by about 10 per cent.

This leaves the Irish banks looking quite cheap relative to continental European banks. AIB's price-earnings ratio of 11.1 compares with 15.2 for Spain's BBVA and 12.7 for Société Générale. It is higher than RBoS's 8.7, but on dividend yield comparisons, the Irish banks compare favourably with both their UK and European peers.

Although competitiveness issues are an ongoing concern, the medium-term prospects for the Irish financial sector are favourable. The growing population and workforce will fuel the demand for all types of financial products and the low inflation/low interest rate environment of the euro area provides a very stable macro economic background.

Intense competition and the stated intentions of several new entrants to establish footholds in Ireland will put a lid on the profit growth of the incumbents.

Nevertheless, Investor feels that recent underperformance has been overdone and a modest rally in the main Irish banking stocks would now be justified.

Investor says...

Although competitiveness issues are an ongoing concern, the medium-term prospects for the Irish financial sector are favourable. The growing population and workforce will fuel the demand for all types of financial products.