Philip Lane: Economy still vulnerable to Brexit risks

Ireland’s economy has so far weathered the storm but remains “especially vulnerable” should the UK fail to strike a favourable deal in its Brexit talks with the EU, says Central Bank governor Philip Lane.

He said the Brexit vote has not yet riled financial markets or scared investors to the extent some had feared, but there are no guarantees the calm conditions will last.

The outlook favours a broadly based upturn, even though the economy remains particularly vulnerable to outside economic shocks, he said.

In a speech billed as an end-of-term report, Mr Lane told the Institute of International and European Affairs think-tank that two recent stress tests by the European Banking Authority and the IMF showed Irish banks were “adequately capitalised”.

But lenders here remain vulnerable to an economic shock as they work through their “problem loans” inherited from the crash.

Mr Lane said markets have so far focused on the likelihood that central banks would likely prolong the era of low interest rates, which has led to further drops in the cost of sovereign bond yields, as well as “a related” drop in bank shares.

He said an outcome of the UK and the EU talks that would lead to a “harder form of Brexit” may yet upset markets.

“Moreover, in view of its tight economic and financial linkages to the UK and its high levels of private and public sector debt, Ireland is especially vulnerable to any Brexit-related reversal in international financial sentiment,” said Mr Lane.

Before the June 23 referendum, sterling was trading at around 78p against the euro, but has weakened to 84p.

A sudden drop in the value of sterling has in the past made it more difficult for Irish exporters to sell their goods and services at competitive prices.

Mr Lane said the Central Bank had cut its growth outlook for the Irish economy, in its quarterly report published last week, partly because of the lower growth prospects for the UK economy and the fall in the value of sterling.

Indigenous firms, including agrifood and tourism industries, are exposed to the value of sterling, said Mr Lane.

However, sterling’s recent fall has reversed its huge appreciation over the previous two years, and is currently trading “remarkably close” to the 85p average between 2009 and the summer of 2014, he said.

The governor said the recent stress tests conducted on European banks by the European Banking Authority “inevitably” led to worse outcomes for Irish banks because of the country’s recent experience of the banking crisis and the rapid accumulation of bad loans on the banks’ loan books.

He said the lesson of the EBA stress test and of the IMF’s separate Financial Sector Assessment Programme was that “the risks within the banking sector” were “manageable”, though “unsurprisingly it also highlighted that some vulnerabilities still exist as a consequence of the recent crisis”.

“As with the FSAP stress test results, the primary message from the Irish banks included in the EBA sample — AIB and Bank of Ireland — are adequately capitalised but remain vulnerable to a downturn, especially in relation to the continued workout of problem loans and the sustainability under stress of current profitability levels,” said Mr Lane.