The Irish economy is overly dependent on the housing sector and the Government should act to quell growing signs of irrational exuberance among consumers, a leading economist warned today.
In his latest quarterly outlook, Friends First economist Jim Power said that while the economy on track for another strong performance in 2006, a correction in house prices would severely damage consumer confidence and would undermine the overall economy.
Friends First economist Jim Power
"There is no doubt that the economy is performing strongly, but this performance is over reliant on the housing market which is exerting an inordinate influence on the overall health of the Irish economy," warned Mr Power.
Mr Power said Irish consumers' "incredible willingness to borrow" is being fuelled by rising salaries, the prospect of maturing SSIA funds and low income taxes.
Echoing the phrase made famous by Alan Greenspan before the dot.com crash Mr Power warned that "Consumer spending is on fire and there is strong evidence of irrational exuberance.
"Against this background it is not surprising that inflationary pressures are starting to re-emerge and it would now be prudent for Government to tighten fiscal policy. However the political cycle militates against this," said Mr Power.
Mr Power explained that the lopsided growth in favour of the construction sector has made the economy vulnerable to any downturn which could be triggered by a sharp hike in interest rates.
In the final quarter of 2005 construction activity accounted for 12.7 per cent of total employment. Total output from the sector was valued at €30 billion in 2005 or 19 per cent of GDP.
The size of the mortgage market has grown from under €25 billion in 2000 to €100 billion in January 2006, this has contributed to strong growth in financial services sector employment.
"Many house purchasers are taking on mortgages at the upper end of their comfort zone. Between December 2005 and 2006, interest rates are likely to increase by 1 per cent.
According to Mr Power, a large number of the companies quoted on the Irish stock exchange are also heavily influenced by and dependent on the health of the housing market and housing related activities. These include; AIB, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Grafton Group, Abbey, IFG Group, Kingspan Group, McInerney Holdings, Readymix and to an extent CRH.
Any serious setback for the Irish housing market would have a significant negative knock-on effect for these companies and consequently for Irish pension funds and private equity holdings.
"Our policy makers need to ensure that a sustainable indigenous economy is created alongside the housing sector and the public sector. An economy cannot grow on the basis of the public sector and the housing market indefinitely," warned Mr Power.