Central Bank says economy to contract 7% this year

The Irish economy will contract by almost 7 per cent this year and by 3 per cent next year, according to the latest quarterly economic forecast from the Central Bank published today.

The 6.9 per cent forecast decline is more negative than its January estimate of a 4 per cent economic contraction this year.

“It is critical that firm and decisive action is taken to reverse the major deterioration in the general government deficit that has occurred and, if not tackled, is set to worsen,” the bank said in its latest quarterly bulletin.

It expects unemployment to reach 11.75 per cent this year and 14.4 per cent next year.

Decline in almost all sectors of the economy was driving up unemployment it said and this was being accompanied by a severe contraction in discretionary expenditure and a “corresponding rise in precautionary savings by consumers”.

It notes household savings rates are expected to double between 2007 and 2009 which will contribute to a 10 per cent decline in domestic demand.

About half of this decline will come from the housing market where the Central Bank expects the slowdown in activity to accelerate, with around 18,000 houses and apartments built this year, compared with 52,000 last year. In 2010, only 12,000 units are forecast to be built.

As a small open economy where exports account for almost 80 per cent of GDP the accompaniment of the domestic construction collapse with the worst recession since the 1930s means Ireland is being “significantly affected” by the downturn.

It advised the government to focus more on cutting spending than raising taxes in next week's emergency budget, and said it was critical the State get its finances in order by a 2013 deadline.

"The sharp deterioration in the fiscal position has triggered a concern in international markets about the scale of the exchequer's financing needs in current difficult market conditions," the bank said.

"In such circumstances, maintaining the confidence of financial markets requires restoring order to the public finances as a matter of urgency."

The Government will publish its second emergency budget in six months next Tuesday in a bid to stop its deficit rising to 12.75 per cent of GDP, the worst in the European Union, and far above an EU limit of 3 per cent.

According to the Central Bank there is a possibility of a return to growth in 2011 but economic conditions will worsen before then.

“Against this difficult background, it is vital now that we move quickly and credibly to confront the very significant challenges that we face and chart a path that will, in time, ensure sustainable recovery in growth,” the Central Bank said.

In framing the Budget the Central Bank said the Government must achieve significant economies and reform while on the capital side, "priority should be given to those projects which will add most to the productive potential of the economy".

It said tax rates had to be increased and the tax base broadened. "In the interests of raising revenue and limiting demand, consideration also needs to be given to charges for public services that are delivered free at present".

Inflation, as measured by the consumer price index, is likely to fall 4 per cent after showing an average increase of 4.1 per cent in 2008.