The economy here is running the risk of overheating because of rising wages, the Organisation for Economic Co-operation and Development (OECD) has warned. At the same time it is predicting that Europe is set to take over from the US as the engine of global economic growth.

In its twice-yearly international report, the Paris-based organisation criticised current Irish policy. It warned that managing the situation was now a "formidable challenge" and said the Government must act to temper wage expectations.

The Economic Outlook points out that wages are already accelerating despite agreed limits in Partnership 2000. It also warns that further planned tax cuts must not be allowed to fuel demand.

"The Government's primary role in the forthcoming wage negotiations should be to temper expectations," it states.

It also stresses that careful attention should be paid to setting a level of the minimum wage that does not adversely affect the employment prospects of low-paid workers. And, according to the OECD, macro-economic policy has done little to resist "unsustainable increases in spending" and policy has even been stimulating the economy in recent months.

The report points to the downward trend in the exchange rate, sharply falling mortgage and interest rates, sizeable net tax cuts and rising Government spending.

Overall, the OECD is predicting household disposable income will rise by some 8 per cent this year, with demand for housing remaining substantial. Overall growth in Gross Domestic Product is expected to be around 7.5 per cent this year and 6.7 per cent in 2000 following double digit growth last year.

But even this slower level of growth will still leave pressures in the jobs market, the OECD believes. Employers will have to compete to attract and hold on to staff, putting upward pressure in wages in a range of sectors, it warns.

The report was cautiously optimistic about growth across the rest of the world. Interestingly it predicts that growth should hit close to 3 per cent next year as stronger growth in Europe makes up for a slowdown in the US. The OECD also said South Korea and other battered Asian economies were recovering faster than expected and that the threat of Asia's woes spilling into Brazil to the rest of Latin America had been limited.

The OECD is predicting global growth of 2.4 per cent in 1999 - higher than the 2.1 per cent growth it foresaw six months ago at the height of last year's financial turmoil - and it held to a growth forecast of 2.9 per cent for next year.

The OECD forecast for this year almost matched the 2.3 per cent growth predicted last month by the International Monetary Fund (IMF). While the IMF sees 3.4 per cent growth next year, it said at the time this could be overly optimistic. The OECD said it saw less chance of reality undercutting its 2.9 per cent scenario.

Nevertheless, the OECD estimated 3.6 per cent growth for the US this year, doubling its previous forecasts and illustrating the extent to which US resilience has confounded the experts. But it still believes it will lose steam next year after eight years of expansion, with growth slowing to 2 per cent. At the same time the EU will grow at 2.4 per cent, after 1.9 per cent in 1999. The Euro zone will do even better with 2.6 per cent growth next year and 2.2 per cent this year because of easy monetary policy, high consumer confidence and a gradual recovery in export markets.

European growth will still fall short of its potential with problems in Italy and Germany continuing despite recent interest rate cuts to 2.5 per cent. Even here it saw signs of hope with robust consumer confidence in the rest of the Euro zone thanks to rising disposable incomes helping German and Italian exporters, who should benefit from a pick-up in business, the report said. But the OECD said they were not likely to catch up quickly with their more dynamic neighbours, notably France.

It attributed the divergence in part to long-standing problems in eastern Germany and southern Italy that reduce the two countries' ability to adapt to changing conditions. The two countries are also detached from the rest of the Euro area, partly because of their greater vulnerability to the emerging markets crisis, the report said.

The OECD is also predicting a pick-up in Britain. Interest rate cuts should bring economic recovery in the second half of the year, but a further lowering will be needed before year-end.

But both domestic and foreign demand will continue to decelerate short-term, bringing the economy close to a recession and pushing up unemployment before the recovery kicks in.

It said the earlier decision to keep monetary policy tight and the pound's appreciation late last year were currently still dragging on economic growth, which will fall to just 0.7 per cent this year from 2.1 per cent in 1998 before rising to 1.6 per cent in 2000.

Foreign demand, especially, has been weakened by the twin impact of the stronger sterling and fallout from the Asian crisis.