High interest rates 'weigh on' economic growth 

The Central Bank said it expected inflation to continue to decline, reaching 2.1% by 2025. Picture: Leah Farrell/Rollingnews.ie

The ongoing transmission of higher interest rates is going to “weigh on growth” in the economy over the coming years, which is already limited by capacity constraints mainly due to a tight labour market, the Central Bank of Ireland has said.

Following numerous interest rate hikes by the European Central Bank (ECB), inflation has started to come down — dropping to 3.9% in November.

However, in its latest quarterly economic bulletin, the Central Bank said higher interest rates feeding into the system meant the economy had shifted into a “slower growth path following the strong post-pandemic recovery”.

“The growth outlook is uncertain and downside risks have increased,” it said.

Gross domestic product (GDP) is expected to contract for the entire year in 2024, while at the same time the domestic economy as measured by modified domestic demand (MDD) will likely grow, albeit at a slow pace.

GDP is heavily influenced by multinational companies based here. Exports have also been weaker this year but the Central Bank expects this to recover in 2024.

The bank said its growth forecasts were contingent on a rebound in the pharma and information and communication technology (ICT) manufacturing sectors in 2024.

MDD — which excludes the activity of multinationals — is forecast to grow by 1.5% this year, 2.5% next year, by 1.9% in 2025, and by 2% in 2026.

The Central Bank said in light of the “larger than anticipated monetary policy effects” through higher interest rates, the Irish economy could see more “slack in the labour market” than currently projected, and a “somewhat slower” catch-up in real wages.

It said this would “negatively affect domestic demand and reduce inflation more than anticipated”, the bank said. 

In the domestic economy, the pass-through impact of higher interest rates to retail loans and deposits “has become more pronounced”.

According to the bank, the main risks to its projections include: an escalation in geopolitical tensions, prolonged downturns in the pharma and ICT manufacturing sectors, monetary policy changing to something different to the expected, and potential domestic supply constraints.

The Central Bank said it expected headline inflation to return to 2.1% in 2025. The ECB goal is to return inflation to 2% over the medium-term.

Central Bank director of economics and statistics Robert Kelly said as momentum in domestic economic activity decreases, the effects of “tighter monetary policy continue to emerge”.

“The process of disinflation is expected to proceed at a more gradual pace over the next two years,” he said.

The bank said falling energy prices have contributed most to the drop in headline inflation to date and recent data show a marked easing in price rises for other non-energy industrial goods.

The Central Bank is also expecting the labour market to remain tight over the coming years.

As a result of the tight labour market, wage growth is also picking up, partly reversing the real wage declines experienced since 2021 largely as a result of inflation.

However, the bank notes those in lower income households have yet to see their real income recover to pre-pandemic levels.