The economy should gradually improve next year, provided the international recovery gets under way, according to new forecasts from the Central Bank.

Gross national product (GNP) could rise by 3.5 per cent next year, it predicts, up from growth of 1.5 per cent expected this year.

The Bank warns, however, that recovery is reliant not only on an international pick up but also on no further deterioration taking place in the competitive position of the economy.

Its forecasts, contained in its latest quarterly bulletin published yesterday, are broadly in line with the recently published ESRI predictions for 2004.

Despite the prospect of recovery, the Bank expects unemployment to continue to rise to 5.25 per cent of the labour force this year and 5.75 per cent next year.

Total employment, now standing at around 1.770 million, will edge up by around 5,000 people this year and 10,000 next year, it believes.

This will not be enough, however, to absorb the additional number of people looking for work.

Growth this year will be "well below the economy's potential, with GNP rising by just 1.5 per cent, according to the bulletin. This means that Exchequer borrowings could "approach" €2.5 billion this year, the Bank warns, referring to the Department of Finance projections of a €500 million tax shortfall.

The Budget borrowing target is €1.87 billion.

As the Government starts to consider the Budget for next year, the Bank also cautions that spending growth "will have to be more modest than in the recent past in order to match the weaker growth rates of Government revenue in the current weaker environment".

Recent figures suggest the Government will not succeed in its Budget goal of capping public sector employment this year, it says, although private sector employment is likely to fall.

In its first estimate for 2004, the Bank says: "Assuming that the international environment improves in the latter part of this year and that the economy does not suffer a significant further loss of competitiveness, there should be a gradual improvement in the growth rate with overall GNP volume growth picking up to perhaps 3.5 per cent next year."

While the economy was bound to slow from the high growth levels experienced up to 2001, the most important reason for current low growth is the protracted international slowdown, the Bank says.

Lower international interest rates should help to lift the world economy later this year, it says.

An external stimulus is vital for Irish recovery, it says, as the domestic economy will not be able to recover otherwise.

This is because consumers will remain cautious until employment trends improve, investment by business will remain lacklustre and pressure on the public finances means the Government will not in a position to boost the economy through big spending increases or tax cuts.

Faster international growth next year should feed through to higher exports and a more general boost to growth next year, the Bank believes. It warns, however, that any further deterioration in competitiveness could threaten this outlook.

In particular, a further rise in the euro could damage the prospects for exports and employment.

Continued efforts to enhance productivity and efficiency are also vital, it says, particularly in the public sector where benchmarking pay increases are due to be linked to productivity improvements.

While inflation is falling, the Bank warns that it remains well above the euro average. Together with the rise in the euro, this implies further pressure on competitiveness, it warns. Consumer price inflation should ease from 3.5 per cent this year to 2.75 per cent next year, according to the Bank's forecasts.