THE GOVERNMENT faces fresh demands from the EU executive to escalate its austerity plan after economics commissioner Olli Rehn said all euro members should intensify efforts to regain control over their public finances.

Mr Rehn said, however, he agreed with Minister for Finance Brian Lenihan that the worst was over for the Irish economy. He was speaking as the European Commission said in its spring economic forecast that Ireland’s economic contraction will be “much less pronounced” this year and that growth “should resume” in 2011.

But the commission highlighted risks to these assumptions, adding that it could not rule out an effect on the public finances from any State capital injections into banks after their loans transfer to the National Asset Management Agency (Nama).

The commission also said the resumption of growth will be accompanied by “only a very moderate increase” in employment, adding that young and low-skilled workers are hardest hit as unemployment peaks this year at 13.75 per cent.

“I would actually agree with Brian [Lenihan] that it is clear that the worst is over and the Irish economy is now recovering, but it is essential that Ireland will continue vigilantly to take measures of fiscal consolidation and, if needed, take even further measures,” the commissioner said.

The commission “will certainly encourage all euro member states to intensify their consolidation” efforts to stabilise their public finances, he said.

“Ireland entered into the crisis in the very early phase and it had a very deep early recession – and subsequently Ireland took very bold and credible measures of fiscal consolidation, which is now paying off and the Irish economy is recovering.”

The commission’s forecast suggests the rate of contraction in gross domestic product (GDP) will decline this year to 0.9 per cent from 7.1 per cent in 2009. GDP will expand by 3 per cent next year, it adds. Its previous projections had been for contraction of 1.4 per cent this year.

While the first recapitalisation of Anglo Irish Bank brought the budget deficit to 14.3 per cent of GDP last year, the deficit is forecast to decline to 11.7 per cent this year. The budget deficit is forecast to rise on a no-policy-change basis to a little above 12 per cent GDP in 2011.

This calculation, however, takes no account of the Government’s plan to consolidate next year’s budget by some 1.2 per cent of GDP “as the underlying measures are still to be specified in the budget for 2011”. The exception was “the announced retrenchment” of public investment.

“Depending on the specific consolidation measures that are eventually implemented, a dampening effect on domestic demand cannot be excluded.

“Further, if the ongoing financial sector balance sheet adjustment were to intensify due to worsening loan quality in the context of the wider recession, subdued lending activity could in turn adversely affect real activity, inter alia through a dampening effect on investment.”