View from Dublin: volatile currency and huge debts could yet derail us
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 two weeks ago — the ‘National Risk Assessment’ from the government — another part of the analysis-fest 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 long-term 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 1.4%, while prices in Ireland fell by 0.2% 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 1%.
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 7% in the 12 months to July.
The 6% 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.
Companies who are 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 2% in the first half of this year compared with 2016.
Irish households are spending more and simultaneously reducing their debt.
Like much to do with Brexit, the full political and economic ramifications have still to be felt.