Analysis: Still a grim street if Ireland turns the corner

DUBLIN (Reuters) - Ireland has for months been telling its European partners that it can, with their help, deliver a rare good news story to the beleaguered continent, but it can't change the narrative without better newsflow in the rest of the euro zone.

Last week, it appeared help might be on its way, when leaders at a European Union summit agreed to look at improving Ireland's bank bailout, which the government, one of five in the 17-member euro zone that have received or asked for emergency EU cash, has been campaigning for this last year.

Local politicians called the move a "game changer", and the mood has improved further in the days since; Dublin's tax revenues are rising faster than expected, manufacturing and services companies are outperforming their euro zone cohorts, and, following a sharp fall in borrowing costs, Ireland will sell short-term debt for the first time in almost two years on Thursday.

It still faces stiff challenges, not least tackling the worst budget deficit in Europe - 9.4 percent in 2011 - and trying to reverse one of the continent's highest unemployment rates, but it is at least making the sort of incremental progress that may yet see it fully return to the bond market and make inroads on its 85 billion euro ($107 billion) EU/IMF bailout.

"Before the (EU summit) announcement last Friday morning, I would have been of the view that Ireland would not get back to medium-term funding in the market, and that we would need a second (bailout) program to be negotiated," said Dermot O'Leary, chief economist at Goodbody Stockbrokers.

"However, the chances of Ireland getting back to the (bond) market have increased considerably. I think the market will need further details on what shape this deal on bank debt is going to take, but if it works out favorably, I think then Ireland could get back to the market."

An agreement in principle for EU finance ministers to look at Dublin's financial sector with "the view of further improving the sustainability of the well-performing adjustment program" was enough to push yields on benchmark Irish 2020 bonds almost 100 basis points lower to a 20-month low of 6.26 percent.

Ireland wants to soften the bailout terms principally by replacing 31 billion euros of high-interest IOUs given mainly to the failed Anglo-Irish Bank with longer-dated instruments bearing lower rates.

With Ireland's bond yields now bettering those of part-bailed-out Spain, the country's debt management agency relaunched its treasury bill program and will dip its little toe into the funding pool with Thursday's issue of 500 million euros of three-month money.

Ireland is merely catching up with Portugal and Greece, which have issued bills throughout their bailouts, but the debt agency said the short-term issuance marked its phased re-entry to the capital markets.

How much further they can go will depend on what inroads any improvement in the terms of Ireland's expensive bank bailout can make into a national debt pile set to peak at 120 percent of gross domestic product (GDP) next year, right on the cusp of what most in the market consider unsustainable.

"All there is is just a promise that something might be done; that's no change ... it's effectively a family in the divorce court agreeing that they might have a conversation," said Constantin Gurdgiev, an adjunct lecturer in finance at Trinity College Dublin.

"The so-called positive story is not driven by fundamentals. There has not been a change in the underlying fundamentals for Ireland out of the summit. I look at the real economy and see no signs of improvement or stabilization."

"GOOD HOUSE IN A BAD NEIGHBOURHOOD"

If government ministers were still celebrating on Wednesday, they were given a stark reminder of the challenges still ahead when figures showed the number of people claiming unemployment benefit rose to the highest level this year.

That pushed the country's unemployment rate to nearly 15 percent for the first time since its financial crisis began. Only Spain, Greece and Portugal have higher rates in the euro zone.

To get the unemployment rate down and indeed to put its national debt on a downward trajectory, Ireland needs its economy to grow, and government forecasts for a matching of last year's GDP growth of 0.7 percent won't cut it in the long term.

To flourish, Ireland's economic model, built around its export sector, needs a stronger global economy behind it, but with surveys on Wednesday showing Europe's biggest economies were in recession or heading there, there is still no hint of a tailwind.

"I think you could describe Ireland as a success story of the euro zone. That would be accurate, but we're a good house in a bad neighborhood," said Eoin Fahy, economist at Kleinwort Benson Investors.

"The Irish authorities are generally getting it right in Ireland, but without fair wind from the rest of Europe, it's going to be very difficult ... Unless the neighborhood is sorted out, Ireland can't do much about its own house."

($1 = 0.7933 euros)

(Reporting by Padraic Halpin; Editing by Will Waterman)