House price growth threatens economy, warns Central Bank

The Irish economy is under threat from a pick-up in house price growth, Governor of the Central Bank John Hurley warned today.

Launching the Bank’s annual report 2005, Mr Hurley outlined several vulnerable aspects of our economy and noted that despite moderation in the housing market last year recent price jumps were well in excess of incomes.

The Central Bank said this was a concern and increased the risk of a sharp correction in the market.

“For the most part, house price increases over the last decade have been well supported by fundamentals, such as demographics, employment and incomes,” he said.

“However, the recent re-acceleration in house price inflation does not seem to be fully driven by a corresponding upturn in fundamentals. This could suggest that there is a danger some gap may be emerging between actual house prices and the price warranted by the fundamentals.”

But Mr Hurley said there was no way to be precise about this. And he said over-valuation in the market may need not necessarily lead to a sharp correction and that prices could ease over time by a combination of a broad stabilisation of prices and continuing improvements in the fundamentals.

“This gradual easing over time continues to be our expectation,” the Governor said.

Mr Hurley also outlined three other risks. Borrowing levels continued to increase strongly and residential mortgage lending has been increasing at annual rates of about 30% in the early part of 2006 while household debt to income ratio is now very high by international standards.

Another risk relates to an over-reliance on domestic demand and employment in the construction sector.

Thirdly, Mr Hurley warned the economy had lost competitiveness in recent years given the already high price level in Ireland and the rising cost base. He said every effort should be made to avoid a further erosion of competitiveness.

There were also warnings about the effect rising energy prices will have here.

The Central Bank’s annual report stated the economy performed well in 2005 with GNP growth of 5.4%. This was a notable increase on 2004, when the figure was 4%. GDP grew by 4.7% last year.

It is expecting 5% growth for 2006.

The strength of the economy was evidenced by another robust performance in the labour market, with an additional 87,200 persons at work and with the unemployment rate averaging 4.3%.

Governor Hurley said: “This labour market performance, coupled with relatively stable economic growth rates over the last few years of about 4.5 to 5% indicates that the economy is operating at capacity.”

He also said the budgetary position remained very sound with general government surpluses each year since 2002, in which year a small deficit was recorded.

On interest rates the governor said the bank was keeping a close eye on inflation and interest rates.

He said: “The Governing Council has signalled that it will exercise strong vigilance to ensure that risks to price stability do not materialise and that inflation expectations are kept firmly anchored.”

But Governor Hurley insisted there was no such thing as pre-determined action when it came to dealing with interest rates adding that action was based on an assessment of risks to price stability.

In 2005, the Central Bank recorded a profit of €122m, compared with €107m for the previous year. The Surplus Income paid to the Exchequer was €109.2m. Some €45m, from the net proceeds of coins issued during the year, was also transferred to the Exchequer.