The economic risks from the cost-of-living crisis and higher interest rates are growing, and more households will likely face financial distress and vulnerable firms will become loss-making, the Central Bank has warned.
In its latest Financial Stability Report, the regulator sets out the threats posed from soaring inflation, slowing or recession-bound global economies, and from the fallout from the hikes in interest rates the European Central Bank and other central banks around the world are employing in their fight against inflation.
The Central Bank has also moved to increase its so-called Countercyclical Capital Buffer, or the amount it demands that Irish banks set aside, to 1%, and has for the first time introduced leverage, or borrowing and debt controls, on Irish property funds, to face down long-flagged risks for the funds that invest in Irish commercial property, such as office and retail projects, as interest rates rise.
As inflation hits budgets and rates rise for the first time in a decade, the Central Bank estimates that the share of households at risk of financial stress could rise by a third, although it believes strong employment and savings will help “households to withstand current shocks”.
“The share of households at risk of financial stress is modelled to rise by up to a third due to the inflation and interest rate increases experienced during 2022, although reduced consumption in the face of higher prices may further support some household budget positions,” according to the report.
For businesses, the inflation crisis will hit the profits of many small firms and to make a small group of SMEs loss-making, which are likely to include those firms that were already struggling during the pandemic, the Central Bank report said.
The risks have increased for Ireland’s corporate tax revenues, the Central Bank said, referring to the recent announcements of layoffs by large tech multinationals, which account for an outsized share of total corporate tax receipts paid to the exchequer.
The number of tech layoffs in Ireland is currently at a low level, but the risks have increased from the tech sector nonetheless since its earlier review, the Central Bank said.
Citing the financial turmoil that rocked the UK bond market in September, the Central Bank said it is acting to detect “pockets of vulnerability” as the financial system faces the new inflation stress.
“A range of financial vulnerabilities, across financial and real estate markets, highlighted in numerous Reviews in recent years, are now being tested under a higher interest rate environment,” the report said.
However, the Central Bank also said that households and Irish banks have built up “resilience” since the financial crash, and a strong labour market and economic growth in 2023 will help many to weather inflation and rate rises.
Summing up the threat from inflation crisis, Ireland faces the risk of “a severe and prolonged domestic macroeconomic shock, challenging the financial positions of households and corporates”, according to the report.