Economy to shrink by 9.8% - OECD

The Organisation for Economic Cooperation and Development has made a relatively pessimistic forecast for the Irish economy in its June economic outlook.

According to the OECD said it expects Ireland's economic output (gross domestic product or GDP) to decline by 9.8 per cent this year compared to a decline of 7.7 per cent predicted by the Minister for Finance Brian Lenihan in the April supplementary budget.

In April the Government set a borrowing target of 10.75 per cent but the OECD reckons this will widen to 11.5 per cent this year and to 13.6 per cent next year.

Irish unemployment is expected to rise to 12.2 per cent this year, according to the OECD and to almost 15 per cent in 2010. Inflation, as measured by the harmonised index of consumer prices, is expected to fall to -1.3 per cent this year. This measure excludes the impact of mortgage interest repayments.

"The [Irish] economy is experiencing a severe contraction as large domestic imbalances correct, compounded by the global downturn and financial crisis. With the recession already well entrenched and further contraction expected, the peak-to-trough fall in GDP is set to reach 14 per cent", it said.

The OECD said Irish economic activity will recover in 2010 but at a slow pace.

"With severe pressure on the public finances, it is appropriate that fiscal consolidation has begun. Substantial spending cuts and increases in taxation are required in the coming years."

"Problems in the banking sector must be resolved at a reasonable cost. Competitiveness would be restored by lower wages and stronger competition," according to the OECD's summary for Ireland.

For the wider group of 30 member countries the OECD said the slowdown was close to the bottom.

This is the first time in two years that its outlook has improved, although it notes soaring unemployment and ballooning budget deficits could knock a weak recovery off track.

It predicts growth of 0.7 per cent for the member states next year after a 4.1 per cent fall this year, a more optimistic forecast than for Ireland.

"This is the first time since 2007 that we have revised up the projection," OECD chief economist Jorgen Elmeskov said.

"The bad news is that the projection still implies that we are only nearing the bottom now and the recovery that follows is going to be a very slow one, probably a fragile one."

World trade will gradually stabilise and then slowly pick up from around the end of this year, the OECD said.

The OECD praised US stimulus policies, saying they paved the way for a recovery in the second half of 2009.

Japan is also showing signs that the contraction is near the end but the recovery is likely to be slow and the economic slack will likely further entrench deflation, the report said.

However, evidence of a pickup in the euro area was harder to pin down because of country-specific issues including housing bubbles, declining exports and problems in the financial sector.

"The eventual recovery may also be slow in this region, including because rising unemployment makes consumers more reluctant to spend," the OECD said.

In China, and in other large non-OECD countries, the recovery was expected to be more rapid, the OECD said.

The report said the risks to the outlook were more balanced than before. Its assumption that financial markets would not return to normal before 2010 might prove too conservative.

"In terms of the downside, one is that if we do not have convincing plans for fiscal consolidation...the other is the further rise in unemployment will weigh more on household spending than what we have put in," said Mr Elmeskov.

Average unemployment in the OECD area would rise to 9.8 per cent next year from 8.5 per cent in 2009.

In order to avoid curbing the downturn, it was important to avoid premature withdrawal of fiscal stimulus where there is room, the OECD said.

Countries with relatively low debt, including Germany, Canada, some Nordic countries and Switzerland, have scope for further policy easing in 2010.

But the state of government finances in other countries, such as Japan, Italy, Greece, Iceland and Ireland did not leave any further room for manoeuvre, without a strong adverse reaction in financial markets.

Failure to send the right signal about withdrawing stimulus could spark inflation fears, lead to further increases in bond yields which could hamper the recovery.

The OECD also urged central banks to keep interest rates close to zero throughout 2009 and 2010 to allow the recovery to take hold, adding that the European Central Bank was not yet at this point.

Central banks should also keep non-conventional measures in place until the recovery is underway and conditions in financial markets return to normal.

Additional reporting Reuters