LONDON — Already reeling from a banking crisis that is threatening its financial credibility, Ireland suffered another setback Thursday when fresh data showed that its ailing economy shrank 1.2 percent in the second quarter.
The decline, after growth of 2.2 percent in the first quarter, surprised many analysts, who had expected the expansion to continue. It also raised the prospect that the Irish economy, hamstrung by a real estate market that has slumped 50 percent and banks that are barely lending, may not soon recover.
The bad economic news, combined with continued uncertainty over how much more the country must invest in its depleted banking companies, led to a further increase in Irish 10-year bond yields, to a record 6.6 percent.
Weak growth spells trouble for Ireland in two important respects. With a budget deficit equal to 11 percent of gross domestic product, the economy desperately needs a pickup to generate tax revenue.
Perhaps more important, though, is the effect on its banks.
As the government is largely liable for the country’s worstperforming loans, a stagnating economy means more real estate loans going bad that the government must cover - especially in the case of Anglo Irish, the troubled commercial bank that the government now controls. The total cost to the government to fix the banking system is expected to be close to 30 percent of overall economic output.
Not all economists were surprised by the new data, however.
Antonio Garcia Pascual, an economist for Barclays Capital, said the figure was to be expected, given the government’s fiscal retrenchment and the unwillingness of consumers to spend.
“I don’t think this is terribly bad news,” he said. “It was discounted in the market.”
The Irish economy sank 7 percent last year, and many economists expect it to shrink 1 percent this year. Pascual said he expects growth of 2 percent next year.
Still, the markets were not so sanguine, latching on to the figure as a sign that the economy was headed for a doubledip recession. The cost of insuring Irish debt hit a high of 4.9 percent.
With growth prospects in Greece, Portugal and Spain looking weak as well, the economic report from Ireland underscores just how hard it will be for the governments in these countries to foster a recovery after they imposed deep austerity programs.
Adding to the negative mood, the data provider Markit reported that its preliminary purchasing managers’ index for the euro area fell in September. The decline, which was more than had been expected, reinforced the view among analysts that the recovery in the eurozone was losing steam.
Stocks in Europe were off about 1 percent in late trading.
In Ireland, which was among the countries hit hardest by the crisis, the cuts to public-sector wages and pensions have been the most severe. That gave the government some breathing room last year as Greece and Spain drew investor scrutiny.
Unlike those two countries, though, Ireland has also experienced a full-fledged banking crisis, leading the government to guarantee the liabilities of the major banks.
The Irish government has said that within two weeks it will announce the full cost of propping up Anglo Irish, which was nationalized early last year. The government is expected to put in $33 billion, and it said that the bank would be split up and eventually wound down.
Business, Pages 28 on 09/24/2010