Economics:World stock markets have had a roller-coaster ride in recent weeks, with Irish equities in particular being badly hit amid the credit crunch crisis on fears of a significant downturn in the Irish economy, Alan McQuaidwrites.
World stock markets have had a roller-coaster ride in recent weeks, with Irish equities in particular being badly hit amid the credit crunch crisis on fears of a significant downturn in the Irish economy. Differences between the way the world's central banks have tackled the crisis have been thrust into the spotlight, with the Bank of England forced to rescue Northern Rock and the US Federal Reserve cutting its key lending rate by half a percentage point on Tuesday.
Until now, the European Central Bank (ECB) has been pumping large amounts of liquidity into the system, but has failed to bring eurozone three-month money rates back down. Indeed, the rise in short-term funding rates for banks is equivalent to a 50 basis point tightening in the ECB's base lending rate.
As yet, these higher borrowing costs for banks have not been passed on to consumers, but if the crisis goes on much longer in the inter-bank market, it is only a matter of time before consumers take a hit. On top of that, the rise in the euro against the dollar is also equivalent to further monetary tightening on a euro zone economy that is already showing signs of slowing down.
Meanwhile, the ECB continues to fret about price stability, though admittedly it has toned down some of its comments recently. Worries about inflation appear overdone, with the annual inflation rate coming in at 1.7 per cent in August and below the central bank's effective 2 per cent target. However, there is nothing quite like a financial crisis to jolt central bankers into action.
The history of the past 50 years or so has been one of a steady build-up in debt, punctuated by periodic crises that threatened to topple the whole financial edifice. Each time the world's central banks have found a way to stave off disaster (mainly through lowering official interest rates), and in the process set the scene for even greater excesses down the road. It is unlikely to be any different this time.
Even though the central banks are trying to resolve the financial market problems in their jurisdiction in their own way, there is a feeling that this is a global crisis that can only be resolved with co-ordinated interest rate cuts from the world's major central banks. The Federal Reserve led the way on Tuesday, and the question now is whether the Bank of England and ECB will follow suit?
While Europe's two major central banks continue to signal that no official rate reductions are imminent, they have relaxed their overall "hawkish" stance, suggesting that an easing of monetary policy cannot be ruled out over the next few months, especially if market conditions do not improve in the meantime. And who will be the biggest winners from an ECB rate cut? Ireland and Spain of course, the two countries that have been targeted by investors as being most at risk from the ECB's tightening cycle and the end of the property market boom.
At this stage, it certainly looks like we have seen the last of the rate hikes in the ECB's tightening cycle as it is hard to envisage the central bank pushing up rates further at a time when the Federal Reserve is easing policy and the euro is appreciating against the dollar.
Even unchanged rates from the ECB over the next six months would be positive for Ireland in my view, but lower rates would give a timely fillip to consumer confidence, and quite easily lead to a recovery in the domestic property market next year. Some economic commentators and certain sections of the media continue to focus on the implications of falling property prices and a sharp fall-off in house completions on the economy. I see house completions falling to just over 73,000 in 2007 and to 64,000 in 2008.
However, the important point is that the non-housing element of construction is likely to remain strong, and the fixed investment component of GDP should also receive a boost from machinery and equipment spending, particularly aircraft.
The Construction Industry Federation has already said that "repair and maintenance" is taking up a greater proportion of construction activity, worth more than €4 billion to the economy and infrastructural projects under the National Development Plan will ensure that the sector continues to be a key contributor to economic growth going forward.
Negative projections on construction job losses in 2008 have been put at 30,000 to 40,000 though I think they will be somewhat lower at around 20,000 and most of these are likely to be non-nationals with a limited impact and/or contribution to economic growth. The construction sector is not headed for meltdown.
The global credit crunch has raised fears of a serious US/world economic slowdown, but I believe these worries are overdone as the rest of the world is now better placed to cope with a fall-off in US growth. I'm sick to death of people writing off the Irish economy and next year could easily see the "Celtic Tiger" roaring more loudly than many pessimists think.
Alan McQuaid is chief economist at Bloxham Stockbrokers. The views expressed are the author's own.
