Analysis: Central Bank warns that high prices and growth in mortgages could hinder the Republic if there is a global recovery, writes Cliff Taylor, Economics Editor

The old saying about the role of central banks is that their role is "to take the punchbowl away just when the party gets good". The difficulty for the Central Bank of Ireland is that, since the introduction of the euro, the punchbowl moving is done in Frankfurt, with little regard to the merriment of the Irish populace.

This creates some conundrums for our Central Bank governor. Presenting its annual report yesterday, governor Mr John Hurley clearly expressed concern about the rise in mortgage lending.

The traditional way for a central bank to remove the lending punchbowl is to raise interest rates. However, as a member of the governing council of the European Central Bank (ECB), Mr Hurley conceded that lower interest rates were possible in the months ahead, if the recent cuts did not stimulate the euro-zone economy.

Mr Hurley's overall message was carefully measured. The economy had been reasonably resilient against a difficult international backdrop, he said, managing, so far, to hold on to most of the benefits of the boom. But he warned that significant risks remained and a return to more rapid growth could not be guaranteed.

First is the uncertainty of the international climate. The euro zone was not set to pick up until next year, Mr Hurley said. He said that the ECB would "wait and see" the impact of the latest interest rate cut before deciding whether another reduction was necessary. However, he added that "undoubtedly there is scope to cut interest rates if that is necessary" - a significant signal at a time when rates are already at historic lows.

For the Republic, the Central Bank has cut its gross national product (GNP) growth forecast this year to 1.5 per cent from 1.75 per cent previously. Reflecting the poor international environment and its impact on multinational exports, the Bank has reduced its gross domestic product (GDP) growth forecast by a full percentage point from 3.75 per cent to 2.75 per cent. (Multinational profit repatriations are included in GDP but excluded from GNP, meaning the growth rates of the two aggregates have been quite different in recent years.)

Even if international recovery arrives, the Bank sees risks that could hinder the domestic economy from picking up speed. It reiterated its concern that, with the actual level of prices here being 12 per cent above the euro-zone average, the Republic has a long way to go in regaining cost competitiveness.

The inflation rate is falling, the Bank believes, but Mr Hurley said the aim must be to get the rate to 2 per cent and keep it there, as this is the ECB goal.

The Bank repeated its call for other measures to improve competitiveness, particularly in the light of the squeeze from the rising euro. These include tight control of Government spending, an insistence on productivity improvements in public spending in return for the benchmarking pay awards and a general drive to increase productivity in the sheltered sectors of the economy and in indigenous industry.

The other big worry for the Bank is the housing market. The Bank is "disappointed that the level of growth in mortgage lending has not come down further", according to Mr Hurley. The Irish Financial Services Regulatory Authority, which shares a supervisory board with the Central Bank, is examining a study of the mortgage lending policy of institutions, but Mr Hurley said yesterday that it was too early to comment.

The Bank is not predicting a housing "bust". However, it is concerned that financial institutions are facing "temptations to cut corners in pursuit of income" - in other words, extending inappropriately large loans - and this could leave banks and borrowers vulnerable in the event of a sustained downturn, with serious repercussions for the economy.

Recent history is "replete with examples of financial crises being preceded by rapid loan growth and asset price escalation", the Bank warned. While the banking system is healthy, the Bank goes as far as saying that a persistence of credit growth and house price inflation pose risks to stability.

These are strong words from the Bank, which believes that the property market is moving into balance and, while it does not say as much, may well fear that parts of the market are vulnerable to a downturn, particularly the buy-to-let market where demand is falling.

The Bank says the property market will hold and stabilise - but as Mr Hurley put it, "the property market is the property market" and volatility could be in prospect if economic conditions were to take a turn for the worse.