It is early days yet in the government austerity programme (austerity feels interminable!),considering it is under way about a year and a half compared to about six previous years of often profligate spending.Assuming the government sticks with the austerity plan agreed with the EU Commission for another year,interest rates on Irish bonds and Irish banks' international borrowings could begin dropping sharply-maybe two percentage points on ten year government bonds-as fears of an Irish sovereign debt default recede in financial markets. This would lift a massive drag on the economy given that the disinlation and deflation trends in most industries except semi-states make present interest rates very high in real terms.
By removing this drag, a two percentage point drop in interest rates would likely power a strong economic recovery. The government would be less likely to increase taxes as its interest burden lightened and this coupled with the reduction in mortgage and business loan interest rates would encourage both consumers and business* to increase spending strongly. Lower interest rates could also lead to an increased supply of credit to small businesses which desperately need credit. Irish banks could use the two percentage point drop to widen the spreads earned on small business loans over the banks' own costs of borrowing,which would make such lending very profitable indeed.
This outlook could be undermined by several possible negative developments,such as a double dip recession in Europe,a tsunami of Irish mortgage defaults that would require the nationalisation of Irish banks and an attempt by the government to reduce the deficit by increasing taxes instead of cutting spending. The odds of these happening are probably low.
*UK businesses now hold the highest ever proportion of liquid assets and cash to total assets by historical standards, which could power a major economic expansion if and when confidence returns. An interesting question is whether large Irish businesses are in that position.