Rising levels of unsold housing stock will drag down economic growth to just 2.5 per cent next year, according to a new report by Goodbody Stockbrokers. Laura Slattery reports.

The forecast by Goodbody economists Dermot O'Leary and Deirdre Ryan is the gloomiest outlook to be made so far for the health of the Irish economy in 2008.

The downturn in the housing market will get worse before it gets better, with house prices likely to drop 13 per cent from their peak by the end of 2008, according to Goodbody's Reconstructing Ireland report.

There is now 12 months' supply of second-hand housing stock for sale, compared to the usual average of seven months. Some counties, including Roscommon, Cavan and Leitrim, are more badly affected by the oversupply than others.

As the construction industry reacts swiftly to the glut of unsold properties, the number of new houses built next year will drop dramatically to 50,000, down from 75,000 this year, Goodbody said. This contrasts with a Department of Finance estimate that there will be more than 60,000 houses built next year.

The Government should now act to improve confidence and activity in the housing market by adjusting the stamp duty regime, according to Mr O'Leary.

"It is the most potent tool at the disposal of Government to return liquidity to more normal levels."

House prices will drop 5 per cent this year and will plunge by a further 8 per cent next year, according to Goodbody, which said the Permanent TSB/ESRI house price index is underestimating the extent of the price falls that have already occurred.

This is because developers are propping up the price of new homes by adding incentives such as a higher standard of fitouts, white goods and even cars as part of the purchase price.

As house prices plunge further and the cycle of rising interest rates comes to an end, affordability for first-time buyers will improve, Mr O'Leary added. In the meantime, average rents are likely to continue climbing.

Goodbody predicts that the unemployment rate will increase to 6 per cent next year, which is higher than the Department of Finance's estimate of a 5.5 per cent unemployment rate in 2008.

Because of the speed at which the construction sector has reacted to the slowdown, Goodbody said the effects on the economy would not linger, and it is anticipating that growth will bounce back to 3 per cent in 2009. But its forecasted growth rate for 2008 is less than half the rate of economic growth that Ireland has enjoyed in recent years.

Analysts at Goodbody yesterday cut its earnings forecasts for a range of stocks connected to the housing sector, including housebuilders Abbey and McInerney and building materials group Grafton. It also slashed its earnings per share (eps) forecasts for AIB, Bank of Ireland and Irish Life & Permanent by 3-4 per cent and downgraded the 2009 eps forecast for Anglo Irish Bank by 9 per cent, as a result of both the lower economic growth estimates and the problems posed by the global liquidity crunch.