Developments in Ireland

In recent weeks there has been increasing pressure on Irish financial markets. Ireland’s sovereign debt markets have effectively closed and interest rates have risen to record levels. In response, on 21 November it was announced that the IMF, EU and its member states, including the UK, would provide an international financial assistance package following a request from the Irish Government. The Chancellor set out that he was considering offering a bilateral loan to Ireland, as part of the IMF and European package, in a statement to Parliament on 22 November.

The pressure on Ireland’s economy has a number of potential implications for our forecast:

• Ireland is the UK’s fifth largest export market and accounts for 6.2 per cent of total exports – larger than the combined share of the ‘BRIC’ economies (Brazil, Russia, India and China). If recent events significantly reduced Irish demand for UK exports there would be a material impact on UK export growth. However, much of this effect may have already occurred: the very sharp decline in Irish domestic demand, which was a precursor to recent events in financial markets, caused UK exports to Ireland to fall by 14 per cent in 2009, worsening the UK’s trade balance by around £4.3 billion. The UK’s trade links with other euro area periphery countries that have come under pressure on financial markets, such as Greece and Portugal, is relatively small;
• the UK banking sector’s total exposure to Ireland is around £82 billion (end June 2010) or 28 per cent of core Tier 1 capital. Around £4.6 billion of this total represents exposure to Irish sovereign debt. This exposure is a risk to our forecast but we do not currently expect this effect to derail the gradual improvement in the financial sector anticipated in our forecast;
• related to this our estimate of the eventual direct net cost to the taxpayer of the financial interventions undertaken in 2008 and 2009 to stabilise the UK financial sector is affected by the exposure of RBS and LBG to Irish liabilities. Further details are provided in Chapter 4;
• any effects on UK interest rates from the increased uncertainty in sovereign debt markets will be captured in our market rate assumption, which is based on average market expectations. The UK 10-year gilt yield has risen by around 35 basis points over the past month, but remains at historically low levels. Similarly, the spread over German bunds has returned to its mid-2010 levels. It is difficult to isolate from wider market developments any direct effect from developments in Ireland on UK rates and spreads; and
• we have not, at this point, incorporated into our central forecast any effect from the UK’s potential contribution to the Irish assistance programme. This is because, at the time the forecast was finalised, no final announcements had been made by the Government, so the effects could not be quantified. We will include the impact in our next forecast assuming the details are finalised. Further detail is set out in Chapter 4.