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Ireland's economic recovery buffeted by Brexit headwinds

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Ian KirwanGlobal Equity Analyst, Eaton Vance Advisers International Ltd.

      London - Ireland has experienced a remarkable economic recovery in recent years. GDP (a much-mooted measure of output for this country) grew 6.7% in 2018 and the Central Bank of Ireland forecasts it to grow 4% in 2019. Unemployment fell to a 10-year low of 5.4% in March 2019, down from the peak of 16% in early 2012. This is spurring both wage inflation, a strong recovery in house prices and improving corporate credit growth.

      The chart below highlights the health of Ireland's economy. However, the sense we got from a recent research trip to the country is that Brexit uncertainty is having a negative impact on the real economy. For example, in a meeting with one of Ireland's major banks, management commented that through 2018/19 they had seen increased caution in smaller SMEs (Small to Medium Enterprises), who are now reticent to borrow and invest.

      Brexit concerns are particularly pronounced in Ireland because the UK is Ireland's largest trading partner. Companies we met with in the building and construction sector that have a big presence in the UK market highlighted that weak sentiment was hampering business. One company told us they had changed their "tone on the UK" over the last three months and now expected profits to contract in 2019. Another firm highlighted that weak trends in building repair, maintenance & improvement were continuing.


      With mounting speculation that Boris Johnson, a leading candidate to be next Prime Minister of the UK, may take the UK out of the European Union with no deal on 31 October, we expect to see more red-flag warnings from politicians and the business community. In late June, Ireland's finance minister, Paschal Donohoe, made some stark predictions about the impact of a "no-deal" on Ireland: a sharp economic downturn, "flat to 1% growth" in 2020 and potential job losses of 85,000.

      Brexit is, however, not the only headwind facing Ireland's economy. Ireland's banks face increasing regulatory challenges. The Central Bank of Ireland is amending regulation and this will allow them to introduce a new systemic risk buffer, thereby further increasing capital requirements. New regulations also make it more difficult for banks with a large retail franchise to attract and retain talent in a strong economy. Regulations impose a €500,000 salary cap and, for variable compensation over €20,000, an 89% tax rate.

      As in the banking industry, excessive regulation is also causing an imbalance in the housing and construction market. Prudent mortgage rules and regulation in the building industry mean supply cannot match demand. Housing starts of 18,000 in 2018 (forecast to grow +20% to 22,000 in 2019) are running below the c. 40,000 annual requirement, which is fueling strong appreciation in house prices, particularly in Dublin and the rental market.

      On a positive note, we see an encouraging trend among companies in terms of capital discipline and corporate governance. Although this may be reflective of the companies we chose to meet with, we felt it was notable the number of times we heard comments on the importance of Return on Capital in driving business decisions and avoiding the use of excessive exceptional charges in the income statement. Attention to environmental, social and governance (ESG) considerations is also increasing. All music to our ears!

      Bottom line: Ireland's economy is in good shape but is being hampered by Brexit uncertainty and excessive regulation. At this stage, it is impossible to assess whether dire warnings about a no-deal Brexit are just scare tactics or grounded in reality, but some degree of caution seems prudent. On the positive side, we are encouraged by corporate efforts to have cleaner accounting and become more shareholder focused. We continue to see investment opportunities among well-run companies with secular growth tailwinds and believe there are opportunities we can exploit relating to Brexit uncertainty.