Can you bag a property bargain in Ireland?

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We all like a freebie. So if you're a househunter living in Dublin, you should have a lot to be happy about.

Buy a house, get your first six months mortgage repayments paid for you. Not bad. Or how about - buy this two-bed apartment; and we'll give you £15,000 worth of shopping vouchers? It's certainly tempting.

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Always on the look out for a bargain, we rang one property agent in Meath, just outside Dublin. He's selling a development of two, three, four and five bedroom houses, and encouraged by what's on offer in the Irish capital, we tried to strike a deal of our own...

The property market in Dublin is looking distinctly unhealthy, so we phoned one property developer to find out what kind of incentive he'd offer us to buy one of his houses.

"If you sign the contract with me within 21 days, I'll throw in the appliances."

"How much will that come to?" we ask.

"About €5,000."

"You couldn't just take that off the price could you?"

"No."

He wouldn't say why not, but the answer's pretty obvious. If he, or any other property agent starts slashing prices, everyone else will have to follow. Better to offer free washing machines and six-months worth of mortgage payments, the kinds of discounts that won't show up in the house price indices.

But unfortunately for the developers, prices are already falling despite their efforts. Irish house prices fell for the third month in a row in May. The average house price is now €304,166, 2.1% below where it was at the start of this year.

And with eurozone interest rates continuing to rise, it's only going to get worse. There have been eight rate rises already since the end of 2005, as the European Central Bank focuses on money supply growth and the resurgent German economy, rather than the plight of smaller members like Ireland and Spain. The ECB base rate now stands at 4%, with most analysts predicting 4.5% at least by the end of the year.

A recent report by University College Dublin economist Morgan Kelly looked at house prices across the OECD since 1970. He found that the higher house prices rise, the harder the fall - fine, tell us something we don't know, Morgan.

But it's the size of the price fall that's most worrying. "Typically, real house prices give up 70% of what they gained in a boom during the bust that follows. This is a remarkably robust relationship, holding across very different OECD housing markets over more than 30 years. Were this relationship to hold for Ireland, it would predict a fall in real house prices of around 40-60%, over a period of eight or nine years. Assuming an inflation rate of 2%, this would translate into an annual fall in average selling prices of 6-7%."

That's bad news for the Irish government. Figures from the Irish Exchequer, released on Tuesday, showed that revenues from property-related taxes such as capital gains tax and stamp duty, were €215m below target. Sure, revenues have grown 5.5% over the past 12 months, but that's down from the whopping 40% growth seen in 2005. If ever there was an indication that fewer people are buying, and at lower prices, that was it.

And there's worse to come. According to a recent note from Capital Economics, "house price inflation appears to have an important influence on consumer confidence." At current rates, it points to a drop in confidence from its latest figure of -7 to more like -20. That's a level not seen since 2003, says the think tank. That level of consumer confidence would suggest household annual spending growth falling to 2% or less, also not seen since 2003. "With residential investment also likely to slow, this could bring GDP growth down below 4% next year for the first time since 1993."

While that isn't bad by most countries' standards, "for Ireland, it would feel like a pretty hard landing. It's been a great party, but the lights could soon come on."

They've been shinning bright for a long time. Since the mid 1990s, Ireland has cut unemployment from 15% to 4.4% and brought more than 1,000 foreign companies to its shores. But in the face of higher wages and lower wage economies in Eastern Europe, those companies could soon leave. Even so, unions are demanding even higher wages, as inflation rises above 5%. So what's next for Ireland?

"The end of the housing boom is going to change the structure of the economy, and the question is how will that transition work", says Dr. Ide Kearney at the Ecomonic and Social Research Institute, who says the main worry is now inflation. "That might feed into wage increases and the Irish competitive situation already is pretty precarious. In terms of export performance, if you look at the last five years compared to the ten years beforehand, exports have been pretty low. We're losing world trade share."

For Ireland to continue to prosper, it has to become less reliant on consumer spending, and house price growth. But if people have their backs to the wall, with their house prices falling and their home loan payments rising, it's going to be difficult to convince them not to keep demanding higher wages. And an expensive labour force is a real disaster for an economy that could be left reliant on foreign direct investment and exports.

What can the UK learn from this? Well, it's fairly straightforward. A lot of people question what's wrong with low rates - partly because we've been living in a low-rate, low-inflation world for so long now that they've forgotten life can be any different. Why do rates have to rise at all, given that it makes life more expensive and threatens our beloved housing bubble?

Ireland shows graphically exactly what happens when you leave interest rates too low and for too long. You get dependent on cheap credit; your other industries wither on the vine as the market distortions resulting from cheap credit (a housing bubble is just one example) fuel mis-investment; and eventually, though it might take longer than you'd ever expect, inflation takes off.

Once that happens, it's too late. As interest rates climb, in a desperate attempt to catch up with inflation, workers will demand higher wages as their asset-based wealth falls, and their incomes are squeezed by rising prices and mortgage payments. This fuels more inflation, interest rates have to go even higher, and your economy is demolished.

So central banks need to get ahead of inflation, not chase it up from the rear. And that's why we should all hope and pray that Mervyn King gets his way at lunchtime today, and again next month. Better a bit of pain now, than a whole lot of carnage in a year's time.

Turning to the wider markets

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In London, the blue-chip FTSE 100 index closed 33 points higher yesterday, at 6,673, although just off the day's highs. The broader indices were also higher. Airline BA topped the FTSE risers with gains of over 5% as investors were cheered by increased passenger capacity, choosing to ignore a 1.4% fall in passenger traffic. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 ended the day 18 points higher, at 6,098, whilst the Frankfurt DAX-30 closed 24 points higher, at 8,075.

On Wall Street, markets were closed for the Independence Day holiday yesterday.

In Asia, the Nikkei was higher again today, adding 52 points to close at 18,221. In Hong Kong, the Hang Seng was 59 points lower, at 22,158.

The oil price hit a ten-month high yesterday as renewed tension in Nigeria threatened supply. Brent spot was trading at $73.78 in London this morning and crude oil was last priced at $71.34.

Spot gold was steady at $654.20 an ounce this morning (for a fuller gold market report, see our daily gold report). Silver was at $12.60.

In the currency markets, the pound was steady at around 2.0165 against the dollar, just off a 26-year peak, and was at 1.4779 against the euro. And the dollar was at 0.7326 against the euro and 122.51 against the yen.

And in London this morning, betting giant Ladbrokes announced a £45m rise in H1 operating profit for its telephone betting operation due to a significant increase in the number of wagers placed by wealthy customers in recent weeks. Ladbrokes shares had climbed by as much as 1.1% in early trading. And be sure to visit Moneyweek.com at lunchtime today to see whether the Bank of England really does raise interest rates, as predicted.

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