May 30, 2024
Economy

Budget spending spree could overheat economy, Central Bank deputy governor warns – The Irish Times


Big tax cuts or spending increases above the 5 per cent rule in the upcoming budget could drive domestic “imbalances” and overheat the economy, Central Bank deputy governor Vasileios Madouros has said.

He also warned another commodity price shock linked to geopolitical tensions in the Middle East and/or further trade fragmentation posed the biggest external risks to Ireland’s economic outlook.

In an interview with The Irish Times, Mr Madouros, who is responsible for monetary and financial stability, highlighted the importance of adhering to the 5 per cent spending rule in October’s budget while the economy is running close to capacity in employment terms.

The rule limits annual increases in public spending to 5 per cent, viewed as a sustainable rate for the economy. The Government will indicate its planned spending increase in Budget 2025 in its upcoming Summer Economic Statement.

“We wouldn’t want to be adding a lot of demand to the economy that would increase the risk of imbalances in the domestic economy,” Mr Madouros said while noting that prioritising investment that helped expand the supply side of the economy could alleviate capacity constraints.

The spending rule was an important “fiscal anchor” as the incoming EU fiscal rules were less relevant to Ireland because of the State’s exaggerated GDP (gross domestic product) numbers, he said.

The Central Bank has, in recent reports, been warning of the financial risks posed by a possible disorderly price correction in Ireland’s €50 billion commercial real estate market, which has been hit hardest by the rapid rise in interest rates.

Mr Madouros noted the real estate sector here had seen a significant fall-off in demand for cyclical reasons (higher interest rates) and structural reasons (increased hybrid working arrangements).

However, he said the exposure of domestic banks to commercial real estate “was much smaller than it used to be”.

He also noted that the estimated 72,500 mortgage holders rolling off fixed rate-contracts and into higher repayment rates this year would be somewhat cushioned by a projected increase in real wages with inflation falling below nominal income growth.

Mr Madouros said the global financial system has been resilient in the face of war, inflation and “a rapid and synchronised increase in interest rates”.

“We have seen a significant disinflationary trend globally but there could still be bumps in the road,” he said, noting recent geopolitical tensions in the Middle East had made for more volatile commodity markets while trade fragmentation had weakened global demand.

The International Monetary Fund warned earlier this month that simmering tensions between US and China had damaged trade flows between countries aligned to each bloc, a trend that could accelerate if US presidential candidate Donald Trump gets elected in November.



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