Euro is Ireland’s life-jacket – and straitjacket

It is hardly surprising that Ireland has warmed to the Lisbon treaty. Ireland is immersed in freezing waters. Europe is its life-jacket.

By Ian Campbell, Breakingviews.com
Published: 12:41PM BST 05 Oct 2009

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The Irish seas could scarcely be more menacing. Only the Icelandic and Baltic economies are in worse shape. Irish GDP has shrunk by 7.4pc in the past year; the inflation rate is a negative 5.9pc; the unemployment rate is 12.8pc. Despite cuts and tax increases, the budget deficit is forecast to rise to 11pc of GDP this year. Government debt, a low 25pc of GDP going into the crisis, is forecast to rise to 59pc of GDP by the end of this year.

At the centre of the turmoil is the burst housing bubble. In August, house prices were down 8pc year-on-year, back to January 2004 levels. But the decline is far from over. The 80pc rise in house prices between 2001 and 2006 provides plenty more downward scope. As does the state of the banks. The government has created a ‘bad bank’, into which the banks are expected to pour toxic debts of E80-90bn – almost half Ireland’s GDP. But declining asset values will keep the pressure on.

In these sinking straits, Europe has come to the rescue. Unlimited 1pc one-year financing from the European Central Bank: that is reassurance. There is also a feeling that if Ireland were unable to pay its debts a lifeboat bearing emergency funds would be sent out. The zone won’t let one of its members drown.

But the EU’s lifejacket is also a eurozone straitjacket. The UK has its competitive, weak pound while Ireland is stuck with the super-dear euro. Ireland’s recession, deflation and budgetary deterioration resemble the Baltics’ agony because like them Ireland is locked into a fixed exchange rate.

"At least we are not Iceland" is the Irish response. The old Irish pound might have proven an Icelandic krona – for a bankrupt island. The euro, for now, is safety. But it leaves Ireland with no easy route back to competitiveness, other than by cutting prices and wages.

That journey will take years and won’t be straightforward. The lifejacket might feel good now, but it will soon start to squeeze painfully tight.

http://www.telegraph.co.uk/finance/brea ... acket.html