The Irish economy is showing signs of overheating, the European Commission has warned in its latest economic outlook.

According to the Commission, the economy here grew by 11.4 per cent in 1998 and is expected to grow by 8.2 per cent this year and 9 per cent next year.

However, the Commission has scaled back its forecasts for growth in the European Union as a whole this year. It now estimates that it is unlikely to reach the 2.4 per cent figure expected last autumn.

In its annual economic report, the Commission said the continuing global financial crisis has started to have an effect on economic activity in Europe and is threatening to undermine a strong recovery that lifted growth to an estimated figure of 2.9 per cent in 1998.

European exports have been hit by weakening of orders, notably from Asia, but domestic demand, which was the main motor of growth last year, is not accelerating fast enough to take up all the slack, the report warns.

The report gives no indication of how big the downward revision is likely to be, saying this will be determined by the extent to which the deteriorating international environment wipes out gains from improving consumer confidence and demand within Europe.

But, overall, the tone of the report is markedly more pessimistic than the Commission was in October, when there was confidence in Brussels that the turmoil that had hit other parts of the world would have only marginal implications for Europe.

But the Commission believes that Ireland will buck the trend in terms of growth - to such an extent that its chapter on the Republic includes warnings of overheating and a pickup in inflation.

The Commission points out that Irish house prices rose by 36.6 per cent in the year to the third quarter of 1998, while private sector credit increased by 25.1 per cent in the year to October.

The Commission also pointed to the ongoing jobs shortage and the pick-up in earnings, where wages in the construction sector have increased by almost 12.5 per cent in the year to June 1998, as signs of overheating.

The Commission identified "evidence of strongly rising wage settlements in the public sector where the public pay bill has increased by almost 10 per cent on average in 1997 and 1998".

Another problem which is beginning to emerge is skill shortages, most notably in the construction and software sectors. It points out that these have to some extent been met by rising migration but nevertheless, there has been a "discernible impact" on earnings growth. However, the Commission did concede that in 1998 these pressures failed to feed through into inflation, which picked up only as a reaction to the fall in the value of the pound against sterling early in the year.

The Commission noted that with the extreme openness of the economy and generally low international inflation, there is little prospect of externally driven inflation. However, it is expecting that strong growth will feed through to more constraints, such as traffic and housing, which will result in more tangible inflation this year. It is predicting that inflation will rise to 3.3 per cent on average in 1999 and in 2000.

It is forecasting an overall slight slowdown this year and next, despite the substantial fall in interest rates and the further reductions in personal income tax in the 1999 Budget. But the strong contribution of exports in 1998 is unlikely to be repeated as inward investment slows down. Nevertheless, export growth is expected to continue to outstrip the growth in Irish export markets as manufacturing competitiveness continues to allow exporters to make gains in market share in line with the previous years.