Asset values across all asset classes have risen in recent years, both globally and in Ireland, on the back of the strength of the economic recovery following the global financial crisis and accommodative monetary policy throughout advanced economies. A range of analysis has taken place within the Department of Finance, the NTMA and the Central Bank, and through inter-institutional groups, of the impacts of changes in asset prices and the overall monetary policy stance.
At its latest meeting in January 2018, the European Central Bank (ECB) made no change to its decision to reduce the scale of its quantitative easing (QE) purchases, whilst also leaving open the possibility of an extension beyond the expected end date of September 2018. This response balances favourable short-run economic data flow and a generally positive outlook against possible market disruption that may occur in the event of an abrupt wind-down. Its previous decision to downsize the rate of monthly purchases was based on a view that the euro area economy no longer needs the same level of monetary stimulus, a view that is supported by recent outturns in the euro area which showed a solid growth rate of 0.6 percent quarter-on-quarter in Q4 2017, or 2.7 percent year-on-year.
The United States Federal Reserve began unwinding its quantitative easing assets from its balance sheet in October 2017. Similar to the ECB, this decision was based on the assessment that the US economy had strengthened enough to no longer require this additional stimulus. The impact of the gradual unwinding, which has been well communicated to markets, is thus also expected to have a limited impact, though some degree of market volatility related to the inflation outlook has been observed of late.
The Financial Stability Group, comprising senior management of the Department of Finance, the Central Bank and the NTMA, acts as the primary vehicle for senior management in the constituent institutions to assess and manage the key risks to financial stability. One of the risks discussed in 2017 was the effects on financial stability of higher interest rates due to the unwinding of QE and by extension the potential effect on asset prices. The Group's view that any negative impacts of winding down the QE programme are expected to be limited, assuming the process remains orderly.
My Department monitors changes in the global economy, as well as stability risks to the Irish economy. However, we cannot control the international environment, and the extraordinarily accommodative monetary policy adopted by the ECB, with the associated decline in sovereign borrowing costs, cannot last indefinitely.
In this regard, my Department published an analysis with Budget 2018 (last October) of the impact of the ECB increasing its policy rates. These simulations show that a one percentage point rise in policy interest rates by the ECB would result in Irish output being one percent lower, and employment being 0.7 percent lower, after 5 years, relative to a baseline projection. The debt to GDP ratio is projected to rise by 2.3 percentage points after 5 years.
The Central Bank has consistently noted the potential for a reversal in risk premia related to any faster-than-expected normalisation in monetary policy as a source of risk in the macro-financial environment (see for example, Macro-Financial Review 2017:II). This scenario has in the past, and will again during 2018, feature in the regular stress testing exercises carried out for Irish and European banks as part of the European Banking Authority EU-wide stress testing exercises. The relative indebtedness of Irish households and firms is also regularly analysed and commented on by the Central Bank, especially the sensitivity of debt servicing burdens given shocks to interest rates.
The Central Bank also occasionally publishes research in the Quarterly Bulletin that reviews developments in the Eurosystem’s monetary operations and impact on money markets, in addition to broader market developments where global central bank monetary policies may have an impact.
The NTMA has been contemplating the end of the ECB’s QE programme since its commencement in March 2015. Through taking pre-emptive action over the past three years, it has significantly improved our debt redemption profile and lowered our debt interest bill. At end-November 2014 the amount of Government bond and EU-IMF Programme related debt that was scheduled to mature over the three year period 2018 – 2020 was some €60 billion. Through the early repayment of IMF and Swedish and Danish bilateral loans, together with the early buyback and switching of near-term maturing bonds for longer maturity bonds, that figure has been reduced to circa €44 billion currently.
Furthermore, reflecting the NTMA strategy of pre-funding, Exchequer cash balances were over €17 billion at the end of January. This means that this year’s €8.8 billion bond maturity in October has effectively already been funded.
These actions offer significant insurance against the possibility of rising interest rates in the coming years. They have also had a very positive impact on the cost of servicing our national debt. The interest bill, which was as high as €7.5 billion as recently as 2014, fell to just under €6.1 billion last year.
It is crucially important that we prepare our economy for any challenges ahead, including a potential shift in global asset values, and continue careful management of the public finances. I would point out that while our debt-to-GDP ratio will continue falling in the coming years (on the basis of my Department's forecasts), this is solely due to rising GDP; in purely money terms, we will continue to increase public debt this year and in 2019. In these circumstances, prudent budgetary policies must be implemented in order to minimise debt interest payments.
