Central Bank Governor Gabriel Makhlouf (small picture) told the Special Oireachtas Committee on COVID-19 this morning that there has been a very sudden and severe contraction in economic activity across the world. 

“The speed and scale with which this unfolded has been unprecedented and has posed an unparalleled challenge to the community and to governments and policymakers everywhere,” he said. 

The policy response has been two-fold, he said, with public health measures which interrupted economic activity followed by a range of fiscal, monetary, macro-prudential and micro-prudential actions to cushion the impact on the economy and the wider community.

Focus

The Central Bank’s primary focus since March was ensuring the financial system absorbed the shock and supported households and firms through the crisis and was ready to support the recovery, he said, with actions designed to ensure supportive financing conditions, enabling credit institutions to absorb losses and to support lending to businesses and households.

Real-time data for the Irish economy point to a trough reached in April, and an increase in activity as the economy re-opens. 

In recent weeks, there has been a return to work in some sectors and a decline in the numbers in receipt of income supports.  Payments data also point to some rebound in spending. 

However, overall, economic output has declined substantially in recent months and remains significantly below pre-COVID levels.

Central Bank projections imply a fall of approximately 20 per cent in underlying domestic demand in the second quarter of this year.

The outlook

“The outlook is very uncertain,” said the Central Bank Governor.

“The path ahead for the economy will depend on the future path of the virus, the degree to which containment measures need to remain in place or be re-introduced, and the immediate and longer-lasting effects on behaviour and economic activity.

Last week the Central Bank set out two scenarios. The baseline assumes that the phased easing of the containment measures takes effect as planned. In a more severe scenario, current containment measures remain in place for longer because of a resurgence of the virus.

Under the baseline, consumer spending is projected to rebound in the second half of this year but to decline by 10 per cent for the year as a whole. 

Overall, the recovery is expected to be gradual, reflecting a lingering effect of the shock on consumers and businesses.  Contact-intensive sectors, which also tend to be labour-intensive sectors, are likely to be the slowest to recover.

The unemployment rate is set to decline from its second quarter peak of about 25 per cent as the year progresses and is projected to be around half that level by the end of this year. 

GDP is projected to fall by nine per cent in 2020 and output recovers to its pre-crisis level by 2022.

Under the severe scenario, GDP would fall by over 13 per cent this year and output would not recover to its pre-crisis level until 2024.

Both scenarios assume that a Free Trade Agreement between the EU and the UK, with no tariffs and no quotas on goods, takes effect in January 2021.

If that doesn’t happen, it is likely that growth in the Irish economy will be weaker.

Policy responses

The unprecedented challenges posed by COVID-19 have been met by exceptional policy action, the Governor said.

The Irish Government’s response to the pandemic will cost around €9 billion, with a further €7 billion being made available through indirect supports such as credit guarantees and rate deferments.  

“Our own immediate macro-prudential policy response was the reduction in the countercyclical capital buffer which made an additional €940 million available to absorb losses or to be leveraged to maintain and extend lending,” Mahklouf said.  

On monetary policy, the Eurosystem has measures for the smooth provision of credit and further operations to support bank lending, as well as expanding the large-scale asset programme, to keep the cost of borrowing for governments low. 

“Overall, the policy actions taken in the area of fiscal policy (by the Government), monetary policy (by the Eurosystem, of which the Central Bank is a part) and macro and microprudential policy (by the Central Bank and other authorities) have helped to mitigate the amplification of the immediate shock and enabled the financial system to provide support through the crisis,” Mahklouf said.  

Future policy

Households, businesses and the financial system have entered the current crisis in a more resilient position compared to the onset of the financial crisis a decade ago, Mahklouf said.  

He continued that three areas deserve careful consideration:

• Policy should continue to focus on supporting the productive capacity of the economy and avoiding scarring effects such as long-term unemployment. Any such action by the Government  is likely to be costly in the near-term but will benefit the fiscal position over the medium term if it is effective in reducing the degree of damage to the economy’s productive capacity,
• the rise in the government deficit and debt ratios is both warranted and necessary and is currently affordable.  But the high level of debt will leave government finances vulnerable to future shocks and it will be important for the Government to provide a clear and credible return to much lower and sustainable deficit and debt positions,
• the country’s ability to withstand the immediate impacts of the shock is partly a result of policy actions over the last decade. There needs to be a continued focus on building economic resilience to future shocks, including a more sustainable debt position but also the longer term structural changes that would help to manage the challenges of international tax reform, the longer-term implications of the UK’s withdrawal from the EU and climate change (among others).