Last Friday morning, 9th November, the Dublin Chamber of Commerce held a Leader’s Breakfast with Philip Lane, Governor of the Central Bank of Ireland. I was delighted to be in attendance and hear the Governor’s thoughts on a range of economic and business topics. Governor Lane’s remarks were around three distinct areas, the Central Bank’s macro outlook, financing of business in Ireland and the Central Bank’s recently launched three-year Strategic Plan. Following his remarks, the Governor took questions from the room, providing a great opportunity for the members of the Dublin Chamber of Commerce to interact with Ireland’s leading economist and arguably, our most influential financial policymaker.
Lane began his remarks discussing the Central Bank’s macro outlook, noting that the current situation in Ireland is strong, a welcome and reassuring assessment from the Governor of the Central Bank. Lane explained that consumer spending is strong and that there has been a large increase in investment including in construction. He says he sees no trigger to reverse the current trend and so the near-term forecast is positive. The Governor stated that domestic demand is due to grow by 5.6% this year, moderating to 4.2% next year and 3.8% in 2020. While this represents decent growth and puts us close to the top of the European table, it is still not the direction we might prefer.
Governor Lane said he expects unemployment below 5% next year so we are getting closer to capacity in the economy. He stressed that we should be using the good times wisely and prudently. Though the outlook seemed positive, Lane did point to two tail risks. The first tail risk is a tightening in financial conditions driven by Fed rate hikes. The second, unsurprisingly, is Brexit, which has the potential to disrupt the international trading system. Lane also mentioned that changes to tax systems might be detrimental to Ireland and stressed the importance of avoiding domestic policy errors.
In terms of macro policy, Lane wisely did not go into too much detail given his audience was a room of business people rather than economists. However, he did note that on the fiscal side, he expects us to have a balanced budget this year and then he stressed the necessity for the Irish government to run budget surpluses in the coming years and large ones if possible to provide a buffer against economic downturns. The Central Bank enacted new mortgage rules this year that limit, among other things, the amounts people can borrow for mortgages to certain multiples of their income. These measures are known as “automatic stabilisers” and are designed to be counter-cyclical. In addition, the Central Bank has enacted counter-cyclical buffers of 1% of capital for Irish banks in July 2018 (effective July 2019). This capital buffer can be immediately released at times of economic stress.
Next, the Governor moved on to financing business in Ireland. There are different funding environments for different types of business, with multi-nationals benefitting from the ability to tap their corporate parents for funding. Large indigenous corporates also usually have easy access to funding, with many able to turn to international bond and equity markets. When it comes to small and medium enterprises, bank finance and retained earnings remain the two capital sources available, according to Lane. In general, SMEs in Ireland are slow to access bank financing and the Governor proposed two reasons as to why this might be. Firstly, the nature of their businesses might mean that they do not need a lot of capital. [True, surely for some businesses but many will need external financing to grow.] And secondly, Lane speculated that the financial crisis may have led to risk aversion in the business community.
Lane went on to say that “it would be unfortunate if the outcome of the crisis was an excessively risk averse business culture”. It is interesting to have a central banker seeming to encourage more risk tolerance from the business community – how the tables have turned. The Governor continued by talking about the cost of bank lending which is "high in Ireland relative to the rest of the EU". He also mentioned that the three largest banks in Ireland have a 93% market share – not a situation that is conducive to healthy competition. Little wonder that ECB Governor Draghi at a recent Oireachtas Finance Committee hearing blamed the “quasi-monopoly” in Irish banking for mortgage rates in Ireland that are double the level elsewhere in the Eurozone. Lane said that closer financial co-operation in Europe will lead to more cross-border lending and stressed the importance of both banking union and capital markets union for the EU and Ireland.
Governor Lane then moved on to the third topic of his speech, the Central Bank of Ireland’s newly announced strategic plan 2019-2021. He said that the last ten years can be thought of in two blocks of five years – 2008 to 2013 where the focus was on managing the financial crisis and 2013-2018 where the bank focused on building a new financial system with a new approach to regulation providing for a more stable view of the future.
The five strategic themes of the new Central Bank three-year plan are maintaining and strengthening the resilience of the system, Brexit, enhancing the consumer protection framework, engaging and influencing and enhancing internal capabilities. Ensuring that financial services firms have enough capital is one of the key features of the strategic goal to strengthen the resilience of the financial system. For Brexit, Lane mentioned weakening of the pound and possible supply chain disruptions as risks. He also noted that a disorderly Brexit would unsettle equity markets and foreign exchange markets. Cable or the exchange rate between sterling and the U.S. dollar is the second most commonly traded currency pair.
Lane said that the Central Bank would be taking a “more intrusive and targeted assessment of consumer risk” when he spoke about enhancing the consumer protection framework, the third strategic element of the Central Bank’s new plan. He also said that the bank would work to enhance cultures of organisations within the financial system to make them more accountable.
When talking about the fourth strategic element of engaging and influencing, Lane noted that the Central Bank of Ireland needs to engage with the public, businesses and the political system in order to be able to have access to different sources of information. He also said that the Central Bank needs to be influential in debates at the EU level and in policy discussions. From my own experience in the Central Bank, where I sat on an ECB committee called the Monitoring Working Group, I was pleasantly surprised at the strength of the Irish voice in policy discussions. The Central Bank of Ireland has worked hard for many years to cultivate a reputation for quality work and serious contribution to policy. It would seem that Governor Lane intends to ensure that this influence will strengthen and grow over time. Finally, speaking on enhancing internal capabilities, the Governor spoke of the need for continued investment in data skills and information systems in order to fulfil its mandates.
There were a number of questions from the floor as the Governor concluded his remarks and opened to Q&A. The first question was about how to attract new entrants to the banking sector in Ireland, given the current lack of competition. The Governor responded by noting that banks must see proper opportunities in the market in order to enter as well as an ability to mitigate risk. We also need to show foreign banking institutions that Ireland has the ability to be “a stable economy”. Banking union and capital markets union will lower the cost of entry for foreign banks, according to the Governor, but how quickly those unions will be enacted is open to discussion. Governor Lane also noted the rise of non-banks providing credit to business and even better, providing equity funding to businesses.
The Governor next fielded a question on whether the financial crisis would have been mitigated if current policies had been in place in the run-up to the crisis in 2004, 2005 and 2006. Lane responded by saying that had there been less household debt and more liquidity in the banking system, the crisis would likely not have been as severe as it was. He also stressed that while a crisis might not now be imminent in the banking sector, one could come in the bond markets. He also noted that while many believe that part of our problem was an inability to set higher interest rates, he doesn’t think this would have been an effective lever for Ireland to push, even if we had had the freedom to raise rates. He pointed to the experience of Iceland, which like Ireland, is a small open economy and where raising interest rates in an attempt to cool their economy actually led to an influx of funds seeking higher interest rates. He said that more intervention in the credit markets and counter-cyclical fiscal policies are more effective tools than interest rates for a small, open economy like Ireland’s.
Interestingly, the Governor somewhat questioned the prevailing wisdom regarding economic cycles by remarking that it is not generally true that the longer the boom, the sharper the bust. Lane said, “The idea that growing fast will inevitably lead to recession is not true. I understand why people think like that but it is not true”. This was an upbeat and relatively contrarian assessment from such an experienced economic expert.
The next question to the Governor was so nicely phrased that it warrants repeating in its entirety; “As a central bank Governor, you are paid to worry. What is keeping you awake at night?” The Governor responded by noting that there are two categories of worry for him – the obvious and the non-obvious. One risk that central bankers think about a lot, according to Lane, is how the global economy will react and adjust to higher interest rates. The markets have become accustomed to a low interest rate environment, behaviour patterns are set and rising rates will be a big adjustment. The longer term risks that the Governor mentioned are cyclical risks like climate change and aging populations.
When asked what the Central Bank of Ireland will look like in 10 years – if it will become essentially just a branch, Governor Lane responded by noting that he is all in favour of regulatory convergence.
This was a very interesting talk and Q & A by a Central Bank Governor who seems eager to engage with the business community and to hear diverse views. Well done to the Dublin Chamber for putting on an excellent event, as always and to the sponsors Eversheds Sutherlands for their support of the event and the very nice branded pens. Nothing better than a talk on the economy and some swag to start the day.
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