Volatile cur­rency swings and huge debt could yet de­rail us

Irish Independent - Business Week - - BUSINESSWEEK -

DE­SPITE all the al­go­rithms, al­phas, be­tas and the rest, by which fi­nan­cial mar­kets make their im­pen­e­tra­ble way, cur­rency move­ments re­main a mys­tery. Which is a pity, be­cause never in our eco­nomic his­tory has the mys­tery mat­tered more.

There was 1991, of course, when ster­ling’s forced exit from the Euro­pean cur­rency sys­tem pro­voked a run on the Ir­ish pound and the Cen­tral Bank used up all its re­serves in the ul­ti­mately doomed at­tempt to main­tain the Ir­ish cur­rency’s value.

But at least one knew that cri­sis would come to an end, one way or the other. There is now no Ir­ish pound to de­fend, al­though if things were to go re­ally badly, there could be a run on Ir­ish gov­ern­ment loans, push­ing up in­ter­est rates and mak­ing the re­place­ment of debt due for re­pay­ment more ex­pen­sive and dif­fi­cult.

This dan­ger was re­ferred to in the most in­trigu­ing pub­li­ca­tion of last week – the gov­ern­ment’s “Na­tional Risk As­sess­ment” – an­other part of the anal­y­sis­fest cre­ated by the cri­sis. It tries hard to avoid fright­en­ing the horses but care­ful read­ing makes it scary enough.

It says the risks to Ire­land’s longterm debt sus­tain­abil­ity re­late mostly to changes to the eco­nomic out­look; pri­mar­ily the growth prospects of key trad­ing part­ners and the im­pact of changes on the in­ter­na­tional trad­ing en­vi­ron­ment.

Brexit is the big­gest threat to the eco­nomic out­look and the trad­ing en­vi­ron­ment, which is where the cur­rency comes in. The mys­tery of cur­rency move­ments means there is no re­li­able an­swer the ques­tion of whether ster­ling will reach parity with the euro, or where it will go at all.

On the other hand, it is of­ten fairly clear why past move­ments took place, as well as the im­pact they had on economies. This is al­ready the case with ster­ling’s re­cent fall. A new Eco­nomic Let­ter from an­a­lysts at the Cen­tral Bank sees sig­nif­i­cant ef­fects last year – and much has hap­pened since then.

The main ef­fect was on con­sumer prices. The pa­per finds that the low rate of Ir­ish in­fla­tion in 2016 was largely due to the weak­ness in ster­ling af­ter the vote to leave the EU.

Not sur­pris­ingly, changes in the euro-ster­ling ex­change rate have a big­ger im­pact on Ir­ish prices than shifts in other cur­ren­cies. The trend seems to be ac­cel­er­at­ing, with in­fla­tion in the euro area reach­ing 1.4pc, while prices in Ire­land fell by 0.2pc in the 12 months to July.

The ECB may soon cut back on the flow of new money de­signed to avoid de­fla­tion, and even be­gin to in­crease in­ter­est rates if core in­fla­tion, which ex­cludes en­ergy, goes much above one per cent.

That would be un­wel­come news for a heav­ily in­debted gov­ern­ment and pri­vate sec­tor such as Ire­land’s; in­creas­ing the al­ready high “real in­ter­est rate” which com­pares the ac­tual rate with in­fla­tion. But as al­ways with this econ­omy the text­book is of lit­tle use, as two re­cent pieces of data show.

Re­tail sales fig­ures show that, ex­clud­ing cars, pur­chases rose 7pc in the 12 months to July. The 6pc fall in car sales is be­ing at­trib­uted to cheaper UK im­ports; a strik­ing ex­am­ple of how the cus­tomer’s gain can be a re­tailer or pro­ducer’s loss and a mi­cro­cosm of pos­si­ble fu­ture trends.

Firms sup­ply­ing the home mar­ket will ben­e­fit from what could be a con­sumer boom. Al­ready, the sales of house­hold goods are ris­ing at a dou­ble digit pace.

The Ja­panese de­fla­tion ogre, where peo­ple post­poned pur­chases in the be­lief that prices would fall fur­ther, does not ap­pear to op­er­ate in Ire­land. Per­haps that is not too sur­pris­ing ei­ther.

It helps that real in­comes are ris­ing faster than real in­ter­est rates. Av­er­age earn­ings rose by 2pc in the first half of this year com­pared with 2016. Ir­ish house­holds are spend­ing more and si­mul­ta­ne­ously re­duc­ing their debt.

Not as quickly as they were, ad­mit­tedly. The small 0.1pc in­crease in loans in the 12 months to July was the first since the fi­nan­cial cri­sis be­gan. Ad­justed for loan sales and se­cu­ri­ti­sa­tions (the mea­sure I pre­fer since see­ing how much the un­ad­justed fig­ures dis­guised the bank­ing cri­sis), house­hold loans are still fall­ing, al­though the 1.8pc drop was the low­est since 2009.

Most of that fall was in home loans, where mort­gages are still com­ing to an end faster than new ones are taken out, even though the gap is nar­row­ing. Other loans in­creased by 3.2pc and there was a €700m a rise in con­sumer debt in the year to end-July.

De­spite that, Ir­ish house­holds still have €8bn more in the bank than they have bor­row­ings – an €80bn swing since 2008 (al­though to­tal debt re­mains high by in­ter­na­tional stan­dards).

The sit­u­a­tion is ex­actly the op­po­site on the other side of the Ir­ish Sea – or in­deed the Ir­ish bor­der. UK in­fla­tion is run­ning at 2.6pc but av­er­age earn­ings are grow­ing by just 1pc; one of the steep­est falls in real in­comes on record.

Con­sumers have re­sponded by in­creas­ing their al­ready sub­stan­tial bor­row­ings. Re­tail sales have been the main sup­port of the UK econ­omy in the past year but that can­not con­tinue in­def­i­nitely.

Like much to do with Brexit, the full po­lit­i­cal and eco­nomic ram­i­fi­ca­tions have still to be felt.

With sur­plus cash in their pock­ets, Ir­ish con­sumers – the most im­por­tant part of the econ­omy – may con­tinue to bol­ster this econ­omy for some time. That is go­ing to make man­age­ment of the pre-Brexit en­vi­ron­ment even more dif­fi­cult.

We may not be able to make cred­i­ble pre­dic­tions about ster­ling fu­ture course but we know why it is weak. Mar­kets fear the ef­fects of a hard Brexit. The more prob­a­ble that looks, the weaker the cur­rency may be­come.

Ir­ish real in­comes will in­crease and per­sonal spend­ing may con­tinue to grow. By the same to­ken, com­pany prof­its will be squeezed, with in­vest­ment and em­ploy­ment the ca­su­al­ties. Pol­icy will be pulled in op­pos­ing di­rec­tions.

Busi­ness has been promised as­sis­tance, pre­sum­ably in the shape of grants and tax breaks for mar­ket­ing and prod­uct devel­op­ment, but it will take more than that.

One les­son from the 2000’s was that Ire­land needs poli­cies to counter the ef­fects of in­ap­pro­pri­ate real in­ter­est and cur­rency rates. De­spite all the talk, that les­son has not been put into prac­tice, but it is needed more than ever.

Some of the wind­fall gains for con­sumers from ster­ling’s weak­ness should be trans­ferred to the threat­ened sec­tors of the econ­omy, which means agri-busi­ness, ex­porters and the gov­ern­ment it­self, in the form of faster re­duc­tion of its un­com­fort­ably high debt.

There is much de­bate among econ­o­mists about the ef­fects of cur­rency move­ments on ac­tual trade and out­put, with ev­i­dence that in to­day’s world, the im­pact on prices is im­me­di­ate but changes to the vol­ume of ex­ports and im­ports are slow and per­haps even neg­li­gi­ble over the long term.

If true, that would be a long-term com­fort for Ire­land as it faces into a world with a volatile and un­cer­tain real ex­change rate but there is a clear and present dan­ger that volatile and un­cer­tain pol­i­tics may do near-ir­repara­ble dam­age in the short run.

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