Central Bank calls for caution in Budget

The Minister for Finance, Mr Cowen, would risk damaging the Republic's competitiveness if he delivered an overly generous Budget in December, the Central Bank has warned.

The caution came as the Bank slightly raised its growth forecasts in its latest quarterly bulletin but pointed to considerable risks to the economy over the next year.

The Central Bank's assistant director general, Dr Michael Casey, yesterday called on the Minister to take a "neutral stance" in the Budget to avoid stimulating too much demand in the economy and spurring inflation.

This would involve modest spending growth of about 7 per cent, coupled with the indexation of personal tax bands to inflation.

Dr Casey said that, while this would keep the public finances in balance by avoiding a large deficit, it would not equate to a "restrictive" budget.

"When the economy is firing on all cylinders, it wouldn't be desirable to add to demand pressures in the economy," he said, calling for a "prudent, cautious" Budget.

He said a small surplus might be desirable in 2005, warning that any significant deficit would be "dangerous in these times of deteriorating competitiveness and rapid growth".

One such danger could be that reduced competitiveness could "frighten off" multinationals that are considering an investment in the Republic, according to Dr Casey.

The Bank expects the economy to post 4.5 per cent growth in gross national product (GNP) this year, up from a previous forecast of 4.25 per cent. A further increase to 5 per cent is projected for 2005, although the forecasts are tempered with a number of health warnings.

Oil looms large on this list of potential threats to economic growth, with the Bank warning that each $10 (€7.87) increase in the cost of a barrel of oil could knock half a percentage point off growth and add the same measure to inflation.

Oil prices have stayed above $50 for the past three weeks and have climbed by about 65 per cent since the start of the year. The Central Bank's forecasts are based on oil prices of slightly more than $40.

The Bank also voiced concerns over the domestic labour market, particularly in the construction sector.

Dr Casey pointed out that some 30,000 workers are currently engaged in building houses, noting that these workers will need to be employed elsewhere when the house-building boom concludes.

While the Bank is expecting a "soft landing" in this regard, Dr Casey said the economic effect of this outflow of jobs remains uncertain.

He urged the Government to stick "rigidly" to the terms of the Sustaining Progress national wage agreement in all sectors as the economy begins to fulfil its growth potential again.

In these "tight" circumstances, spiralling wage demands must be avoided, Dr Casey said. "Drift would be quite damaging," he said, referring to the 5.5 per cent wage increase that Sustaining Progress provides over 18 months.

The Bank expects inflation to average about 2.25 per cent this year and 3 per cent in 2005.

Dr Casey welcomed the latest indications of a softening in growth rate in house prices, adding that recent indications of falling rents may act as a "cautionary tale" to those seeking to enter the buy-to-let market.

He believes that house prices will probably increase by 5-6 per cent next year, before flattening towards the end of the decade.

The Bank reiterated earlier warnings that sustained growth in house prices of 10 per cent or more would make a property crash more likely.