Rising geopolitical tensions is increasing risk to the Irish economy

Rising geopolitical tensions, shifts in global trade policy, and higher economic uncertainty have increased risks to the Irish economy, Ireland's Central Bank has warned in its Financial Stability Review. 

The report is one of the flagship publications from the Central Bank, published twice a year.

It sets out some of the main risks facing the Irish financial system, assesses the resilience of the system, and the Central Bank’s macroprudential policy stance.

The review shows risks facing the financial system have increased.

As a small open economy, with a high reliance on foreign direct investment – especially from the US –Ireland is particularly exposed to recent trade tensions and external developments.

While still vulnerable to global developments, the Irish economy is entering this period of uncertainty from a position of strength the Central Bank said in a statement

"Households, businesses and the domestic banking system have become financially stronger over the past decade, providing a buffer to adverse shocks," it noted.

"The current uncertainty underlines the importance of capital buffers, continued prudent risk management, and building financial and operational resilience."

Speaking on Thursday, Governor Gabriel Makhlouf said it remains unclear where US tariffs – and countermeasures by its trading partners - might settle over time, leaving markets vulnerable to sudden adjustments.

“In the short run, the main channel through which these developments are likely to affect the domestic economy is uncertainty as well as a reduction in external demand," he told reporters.

"There has already been some softening in consumer sentiment and industry engagement points to cautiousness amongst companies, at least for now, in terms of new investments.”

“Any reduction in activity by US owned multinationals, particularly in economically concentrated and trade sensitive sectors such as pharmaceuticals and ICT, could affect employment, tax revenue and investment.

"The economic effects of any such shifts are subject to significant uncertainty and would materialise over a longer horizon.

"From a financial stability perspective, any material slowdown in domestic economic growth could raise credit risks for Irish banks and negatively affect market sentiment towards the Irish sovereign.”

While there is substantial resilience in the financial system, which provides an important buffer against adverse shocks, Governor Makhlouf warned against complacency. 

He said: “Given the ongoing uncertainty, however, it is important that we are prepared for potential macro or market shocks, and that the financial system is maintaining - and indeed, where necessary, building - both financial and operational resilience for the period ahead.

"Cyber and climate-related risks continue to be important sources of adverse shocks. Ensuring resilience remains a key focus of our supervisory and macroprudential work.

"In that context, we are also confirming today that the Countercyclical Capital Buffer rate – a tool used by the Central Bank that requires banks to set aside financial resources to act as a shock absorber - will remain at 1.5 per cent.”

On financial markets, the Governor said the global market volatility in April led to higher liquidity demands for certain groups of investment funds based in Ireland.

"Given the large, internationally-focused non-bank financial intermediary (NBFI) sector in Ireland, we have dedicated a part of today’s report on how different segments of the sector responded to the heightened volatility, that we observed in April.

"At a global level, structural vulnerabilities in parts of the sector mean that the behaviour of non-banks could amplify future market stresses.

"This underscores the importance of continued progress in strengthening the regulatory framework for NBFI, including at a multilateral level,” said Governor Makhlouf.

The Governor also highlighted that for the domestic economy, non-bank lenders or real estate investors that are dependent on market-based financing will be sensitive to shocks in global financing conditions.

He also noted that the fragmenting geo-economic relationships around demographics, climate and digitalisation present clear challenges but also opportunities for Ireland and Europe.

Governor Makhlouf said: “The Central Bank is engaging proactively with the simplification agenda without compromising on the standards required to deliver on our mandate and maintain resilience across the domestic financial system.”

"Harnessing the power of the Single Market, moving towards a genuine Savings and Investment Union, and forging new trade links can have the potential to contribute towards domestic and European financial stability, while also fostering long run economic growth,” he added.

*This article was originally published on BusinessPlus.ie.