Business this Year/Overview:The next 12 months will be a year in which it will be best to avoid living dangerously, writes Paul Tansey, Economics Editor

The party's over. Time has been called on the economic boom and the year ahead will be marked by a slowing rate of economic growth. The deceleration in the pace of activity growth has been triggered by a steep downturn in housebuilding and this is set to continue through 2008. Other areas of the economy should perform quite credibly, while not attaining the heights reached during the boom years. The economy is facing a growth slowdown, not a shutdown.

While the direction in which the economy will move in the next 12 months is clear enough, the pace at which economic growth decelerates remains open to question. The future is always uncertain, but visibility for the year ahead is particularly poor.

In part, this reflects the continuing international banking crisis, initiated by over-exuberant US lending to subprime mortgage borrowers. In part, it stems from the speed of the slowdown in the domestic economy in the second half of 2007.

The national economy performed strongly through the first half of 2007, with consumer spending and exports both exhibiting particularly eye-catching growth. However, the shape of things to come became apparent in the third quarter of the year.

While exports continued to sparkle, the volume of capital investment in the third quarter registered a fall of 7.5 per cent on investment spending in the third quarter of 2006. A decline of 3.8 per cent in construction was the proximate cause of the contraction in capital spending, though there was evidence also of a weakening in plant and machinery investment.

This downturn in investment is likely to have accelerated in the final quarter of 2007 and will carry through into 2008. Housebuilding is the principal component of fixed investment spending. In 2006, it accounted for half of all fixed investment and for over 15 per cent of Gross National Product (GNP). Thus, where housing goes, investment follows.

However, houses are not built in a day. Most of the houses completed in 2008 will have commenced construction in 2007. And, suddenly, last summer, housing starts fell off the radar.

Housing completions achieved an all-time peak at 88,000 in 2006. Recent forecasts from both the Department of Finance and the Economic and Social Research Institute (ESRI) estimate that completions in 2007 will be in the region of 75,000, falling to 55,000 in 2008.

These estimates have informed their forecasts for total fixed investment next year. The Department of Finance, in Budget 2008, forecast a 1.6 per cent fall in the volume of gross fixed investment next year with the ESRI anticipating a larger 3.7 per cent volume fall in capital spending during 2008.

In both cases, the negative signs on fixed investment next year act to drag down the national growth rate for 2008. The Department of Finance is forecasting that real GNP will advance by 2.8 per cent in the year ahead, with the ESRI projecting an increase of 2.3 per cent.

However, both forecasts may still be overestimating housing output next year. Prior to the Budget, the Construction Industry Federation (CIF) was predicting that 25,000 houses would be completed in the first half of 2008. In the absence of any budgetary stimulation, the CIF anticipated that housing completions might reach just 45,000 in 2008. Should the excise duty changes in the budget fail to stimulate the sector and CIF projections prove accurate, then this would clip well over a full percentage point off forecast national growth rates for 2008.

While 45,000 housing completions would represent a halving of housing output on the peak year of 2006, this would not mark a national disaster. Annual housing output had climbed to unsustainable levels, driven upwards not only by rates of new household formation but by speculative demand from personal investors.

Completions increased from less than 34,000 in 1996 to 88,000 a decade later. With investor interest waning, a steep reduction in output is required to lend stability to both future output and prices in the housing market.

In economic terms, a short, sharp shock is infinitely preferable to a long, drawn-out deterioration in housing output. Sour medicine is best taken quickly.

House prices also softened significantly as the second half of 2007 progressed. Towards the end of the year, the ESRI held by its earlier forecast that house prices in December 2007 would be 15 per cent lower than a year earlier.

Since the ESRI had previously estimated that prices were overvalued to the tune of 15 per cent to 20 per cent, such a price fall would effectively eliminate overvaluation.

In consequence, it forecast that house prices would stabilise in the course of 2008. Once house prices are perceived by the public to have bottomed out, transactions volumes will pick up and the housing market will begin to return to health.

THE ATTENTION devoted to housing overstresses its importance in the national economy. A shrinking housing sector will account for just 12 per cent of GNP next year whereas personal consumer spending comprises almost 58 per cent of GNP. Thus, trends in pay and prices, incomes and personal spending, employment and unemployment are of much greater moment to most households than housing completions.

Forecasts indicate that non-farm wages increased by some 5.5 per cent during 2007. The annual inflation, as measured by the Consumer Price Index, increased by 4.9 per cent in the first 11 months of 2007, but this includes sizeable increases in mortgage interest payments. Average prices increased by an estimated 2.9 per cent in 2007 when mortgage interest is excluded.

Nonetheless, pay growth did not outdistance price rises by a sufficient margin to explain the forecast 7 per cent increase in consumer spending volumes during 2007. Three other factors provided added impetus to consumer purchasing volumes over the past year.

First, the 2007 pre-election budget put more money in everybody's pockets, from top-rate taxpayers to social welfare recipients. Second, employment increased by more than 60,000 or by some 3 per cent. Third, and most important, payouts from Special Savings Incentive Accounts (SSIAs) released some €16 billion to consumers in the 12 months to May 2007, with most of the cash arriving this year.

These special factors, which turbo-charged consumer spending in 2007, will not be repeated next year. The SSIAs have left the stage. The Government was decidedly less generous in the 2008 Budget and employment is likely to grow by around 1 per cent at best in the year ahead.

With a weaker economic climate and a looser labour market, average pay growth in 2008 is unlikely to match this year's increases. Pay rises are set to range between 4 per cent and 4.5 per cent with average consumer prices increasing by between 3 per cent and 3.5 per cent in the year ahead, depending on trends in European Central Bank (ECB) interest rates.

Budgetary changes affecting the incomes of those at work have provided indexation but little more. As a result, the real disposable incomes of those at work are unlikely to show much more than a 1 per cent advance in the year ahead. This implies that the average living standards of those at work will edge ahead during 2008, but the corks will be kept in the champagne bottles.

Even where the 6 per cent to 7 per cent budgetary increases in income transfer payments and a 1 per cent addition to the numbers at work are factored in, it is difficult to envisage aggregate real disposable incomes growing by more than 2.5 per cent during 2008.

Allowing that consumers were conservative in the management of their SSIA payouts, a portion of SSIA spending may be carried forward into 2008. Unless there is a benchmarking bonanza, real consumer spending should rise by some 3 per cent next year.

At this time, the outlook for the year ahead is more uncertain than for many years past. In times of uncertainty, caution is usually the best policy. Above all, 2008 is not a year for living dangerously.