I will give a brief summary of the outlook for the economy as the bank sees it. While a wide range of available indicators confirm that the economy is performing well, two factors have made it more difficult to get a clear picture of the performance of, and the outlook for, the economy. I refer first, to the recent large revisions to the Irish national accounts, particularly the very large upward revision to the values of GDP and GNP in 2015, and second, to the outcome of the Brexit referendum in the UK, which has introduced significant risk and uncertainty to the outlook for the economy.
Although recent GDP and GNP measures significantly overstated the growth of domestic economic activity in Ireland in 2015, this should not overshadow the tangible improvement that has taken place. A wide range of more reliable domestic spending and activity indicators suggest that the domestic economy is continuing to expand at a reasonably healthy pace. In particular, consumer spending has continued to grow at a relatively strong pace, supported by solid gains in employment and increasing earnings. Investment, net of intangibles and aircraft, has also been contributing to strong domestic demand, with both core machinery and equipment and construction investment recording double-digit annual growth rates.
A better reflection of what is happening in the domestic economy is provided by the underlying domestic demand indicator that was developed recently by economists in the bank. This is defined as the sum of personal expenditure on goods and services, net government expenditure on goods and services and investment excluding aircraft and intangible assets. This measure grew at a strong pace, close to 5%, in 2015. The strength of the domestic economy was also reflected in an increase of 2.5% in employment. These underlying developments present a more accurate picture of the underlying growth dynamic of the domestic economy.
However, estimates and indicators such as these are merely rough approximations. In view of the distortions now associated with the conventional GDP and GNP aggregates, there is a need to develop more meaningful commonly agreed measures of the level of Irish economic activity that accurately mirror developments in the economy. In this context, the bank welcomes the CSO's initiative in establishing a consultative group that will consider, among other things, the potential for the development of new indicators that will enhance our understanding of the Irish economy. This group will be chaired by the Governor of the Central Bank.
Looking ahead, any assessment of the outlook for the economy is further complicated by the outcome of the Brexit referendum in the UK. The economic impact of Brexit on Ireland is difficult to estimate with precision. It is clear, however, that the impact on the Irish economy will be negative and material in the short and longer terms.
The long-term economic impact of Brexit on Ireland will be influenced by the nature of the withdrawal agreement between the European Union and the United Kingdom. The nature and scale of the eventual macroeconomic impact will reflect the extent to which the exit arrangements bring about changes in free movement of goods, services, capital and labour. Trade, foreign direct investment and the labour market are the key channels for the macroeconomic effects of Brexit. Any agreement which keeps UK access to the Single Market largely intact would have a more limited impact but the scale of the impact could be much more significant under more restrictive agreements.
In the short term, adverse effects on the Irish economy, as well as the UK and broader European economies, arise mainly from the macroeconomic, financial and currency market effects of Brexit-related uncertainty. An important element of this uncertainty revolves around the nature of the long-term relationship between the UK and EU, how long it will take to work out that relationship and how it will impact in the interim. This heightened uncertainty is likely to dampen consumer demand and, in particular, investment decisions by firms. While the economy has become less reliant on the United Kingdom for trade over recent decades, the UK remains a particularly important market for many indigenous firms. Some sectors, particularly agrifood, clothing and footwear, and tourism, continue to have a high dependency on the UK and, consequently, could be affected disproportionately.
The Central Bank’s latest forecast was published in our quarterly bulletin on 27 July and covers the years 2016 and 2017. As well as taking into account information from the latest economic indicators, the forecasts are based on a set of technical assumptions regarding variables such as exchange rates and foreign demand. Importantly, the forecasts incorporate an estimated negative effect of Brexit on the economy, amounting to -0.2 percentage points in 2016 and -0.6 percentage points in 2017. Overall, we forecast GDP growth rates of just under 5% in 2016 and 3.6% in 2017. We see continuing employment growth, with total numbers employed expected to rise by around 70,000 over the two years. Unemployment is expected to decline towards 7%. Supported by continued solid gains in employment, underlying domestic demand is projected to grow by 4% this year and to slow to 3% in 2017. This slowdown reflects a projected negative impact from Brexit-related factors, some normalisation of the catch-up growth seen in earlier years and a fading of the positive effects of lower oil prices on household real incomes.
Notwithstanding this slowdown in domestic demand, the outlook for the economy remains broadly favourable, with unemployment set to continue to fall further. While the forecasts I have presented are deemed to be the most likely outcome given the available information, they are subject to risks. At the current juncture, the risks are clearly weighted to the downside. This reflects the possibility of a more adverse Brexit impact on the UK economy, a larger spillover to the broader international economy or the potential for more negative domestic confidence and labour market effects than we have incorporated into the forecasts.
