Economy faces first contraction in 25 years

The falloff in house construction, high oil prices in the first half of 2008 and the global credit crunch will lead to a contraction in the Irish economy of 1.6% this year, the first decline in national income in 25 years.

According to Bank of Ireland's Quarterly Economic Outlook published today, exports will provide the only substantial support to economic activity.

On housing, Bank of Ireland's chief economist Dan McLaughlin said that because of the correction, residential construction's share of GDP is falling rapidly, so any given percentage fall will have a lesser impact on national income.

He said that while house building accounted for 9.3% of GDP in 2007, it fell to 6.5% by the second quarter of 2008, and is likely to end the year well below 5%.

He said though that there are two positives that may restore some confidence - oil and interest rates.

'Under normal circumstances, the combination of falling inflation and lower interest rates is a recipe for recovery, although market events of late confirm that this cycle is very far removed from anything experienced in recent memory,' the economist said.

He predicts that unemployment will go over 7% next year, moving the Irish economy away from full employment for the first time in a decade.

Separately, analysts say the focus of Bank of Ireland is firmly back on capital, now that its signing of the government bank guarantee has alleviated funding concerns.

In a research note this morning, Davy says investors have already considered 'significant impairment losses' and 'dilutive' fundraising.

The brokers assume that no dividends will be paid by Irish banks for the duration of the guarantee. In its latest interim management statement, Bank of Ireland had already said it was cutting its dividend by 50%.