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Ireland’s domestic economy grew by 2.7% in 2024. This strong growth looks set to continue into 2025 as real wages keep growing, and both fiscal and monetary policies become more expansionary.
However, there is a risk that tariffs, a tight labour market and interest rate cuts push up inflation. We could also see a slowdown in growth if tariffs dampen global demand and US tax cuts prompt multinationals to reduce activity in Ireland.
Domestic economy to continue strong growth in 2025
Modified Domestic Demand (MDD), a measure of Ireland’s domestic economy, grew by 2.7% in 2024 at a time when most European economies stagnated, with some even entering recession.
That said, MDD fell by 1.1% Q/Q in Q4 due to a significant 9.2% fall in domestic investment dragging down growth. Domestic investment is volatile (the average quarterly change is more than 6%), so we shouldn’t read too much into this. However, it could be the first sign that worries about tariffs and global supply chains are taking a toll on confidence. Consumer spending remained strong, growing at 1.6% Q/Q and that looks set to continue.
Overall, we see 2025 as being another year of growth for Ireland where it continues to outperform European peers. We expect MDD to grow by 3% and unemployment to remain low. Real incomes also continue to rise, which will bolster consumer spending. Government spending is anticipated to grow by around 2.8% this year. Combined with growing consumer spending, this should provide a decent tailwind for the domestic economy. Interest rates will continue to fall, providing another boost to the economic outlook.
Risks to Ireland’s economy
However, there are three big risks facing the Irish economy.
First, the Irish economy is heavily reliant on its exports to the US. This means that any potential US tariffs on the European Union will disproportionally harm Ireland’s economy compared to other countries. The current uncertainty already looks to be weighing on investment. It could spill over into exports.
Second, Ireland’s low corporation tax has attracted multinationals to base activities here. This has boosted tax receipts and growth. However, any potential cuts to US corporation tax or attempts to ensure profits are reported in the US will damage both growth and the budget surplus. Fiscal restraint would be needed to prevent a material worsening of the public finances, which would harm growth further.
Third, inflationary pressures are increasing. Higher energy costs, a tight labour market and increased spending all feed into higher prices. Not only are inflationary pressures rising, but the European Central Bank (ECB) is likely to keep cutting interest rates after the 6 March 25bps reduction to support a weak Eurozone. The risk is that inflation in Ireland will accelerate as the economy is already performing close to capacity.
ECB approaching neutral: two more cuts?
The ECB cut interest rates again this month, leaving the deposit rate at 2.5%. Inflation in the Eurozone is down to 2.4% and it looks like the disinflationary process remains on track. The ECB expects inflation to average 2.3% in 2025 and then 1.9% next year.
Further interest rate cuts will help to support weak growth in the Eurozone and the rate of easing will slow as interest rates approach neutral.
While the ECB is confident that the disinflationary process is on course, it will be concerned about stoking inflation. This month it changed its guidance from “monetary policy remains restrictive” to “monetary policy is becoming meaningfully less restrictive” as it starts its approach neutral.
The bank acknowledged that borrowing had become cheaper, but Christine Lagarde, ECB president, said “a headwind to the easing of financial conditions comes from past interest rates hikes still transmitting to the stock of credit and lending remains subdued”. Stripping out the central bank speak, what this really means is that while rates are coming down, it will take time for rate cuts to feed into cheaper credit and more lending from banks so, the effects of higher interest rates will be felt for some time. This is particularly as Eurozone economies continue to struggle and confidence is low in the face of uncertainty, which will make lenders and borrowers alike hesitant.
The bank also lowered its growth forecasts slightly and increased its inflation forecasts, emphasising that the road ahead isn’t necessarily straightforward. Potential tariffs would have a stagflationary impact; increasing inflation while dampening already lacklustre growth. This would create a tough trade-off for the ECB. However, if tariffs induce weaker global demand, combined with already weak domestic growth, then that could create a case for faster rate cuts if disinflation remains on track.
Despite the inflation outlook for Ireland, we expect the ECB to cut interest rates twice more this year. This would leave interest rates at 2%, which is in line with our estimate of the terminal rate. We think risks are weighted to fewer cuts.
Combining rising energy prices with services inflation sticky at 3.7%, the bank may be tempted to hold interest rates at around 2.5% as it begins to test neutral. Defence spending is also set to rise across the Eurozone, which would provide a demand stimulus for growth, but could also push up inflation. In fact, Christine Lagarde emphasised that the Bank will “really adhere strictly to our mandate of price stability” suggesting the Bank won’t hesitate to strike a more hawkish tone if inflation surprises to the upside.
