High levels of debt related to the sharp rises in house prices pose a risk to the economy as well as to individual borrowers and lenders, the Central Bank has warned.
In its fourth Quarterly Bulletin of the year, the bank also urged a "broadly neutral" Budget for 2007 in order to contain domestic inflationary pressures.
It said there had been an increase in the overall level of indebtedness related to the sharp rise in house prices.
"This high, and still increasing, level of indebtedness constitutes a risk to the macroeconomic environment as well as to individual borrowers and lenders," it said.
Central Bank Quarterly Bulletin
It warned that increases in house prices remain a concern and said "affordability issues have become more pressing".
"However, there have been tentative signs, from both housing indicators and anecdotal evidence, of some easing of price pressures in recent months."
The bank said higher interest rates and the increased supply of housing now seem to be acting to moderate house price increases.
"If the current easing in house price inflation were to continue over the coming months, it would reduce the risk of a sharp correction and contribute to a soft landing in the housing sector."
The bank said the Irish economy should grow by 5 ½ per cent this year, a small increase on previous forecasts.
It forecasts inflation of 4 per cent this year, falling to 3 ¾ per cent next year.
And it said that against a "generally favourable international background" the outlook for the Irish economy remains good. The bank forecasts GNP growth of 5 ½ per cent for 2006, broadly similar to last year. It projects continued strong growth, with both GNP and GDP to rise by 5 ½ per cent, also an increase on previous forecasts.
"While the outlook for the Irish economy remains benign, possible issues arise from the pattern of growth. Domestic demand has played a large part in economic growth in recent times, with investment boosted by strong increases in housing output," the bulletin said.
Central Bank
"There are signs now that this increase may be levelling off, based on indicators such as housing starts and planning permissions. Nevertheless, the current scale of activity in the sector is such that it remains vulnerable to a shock to the economy, such as a sudden loss of competitiveness."
The Central Bank said it expected the economy would be able to continue to absorb the relatively strong increase in the labour force and remain at close to full employment, with unemployment remaining in the range of 4 to 4½ per cent.
The Central Bank bulletin also expresses concern that Ireland's export performance remains "consistently below the growth of demand", indicating a "worrying deterioration" in competitiveness.
"In the short-term, wage and price pressures need to be kept in check, while it will be important to improve productivity performance across both the traded and non-traded sectors of the economy over the longer term," it said.
"Improving the efficiency of both the production and use of energy will be key factors for the future competitiveness and productivity of the Irish economy."