Wage and public spending restraint is needed if inflation is not to get out of control, the Central Bank has warned.
Launching the Bank's annual report its Governor, Mr Maurice O'Connell, said the Bank was unhappy with the rate of growth of inflation. However, it has not revised its forecasts of inflation of 4.5 per cent this year.
Inflation hit a 14-year high of 4.9 per cent at the end of April and the Department of Finance has recently revised upwards its estimate for price rises this year to 4 per cent.
The Central Bank expects Gross National Product growth to exceed 8 per cent this year. Mr O'Connell said there were signs of overheating in the labour market, house prices and services. "The present level of growth cannot be sustained. The long-run level should be around 4 per cent to 5 per cent," he added.
The conditions set out in the Partnership for Prosperity and Fairness must be "a norm and not a baseline," Mr O'Connell said. Fiscal discipline must also be adhered to, although this would be very difficult politically, he said.
A hard landing was possible, but not the most likely scenario, he said.
"If the world economy went wrong we would suffer more than most. However, the timing of any slowdown will depend on when productivity starts to drop, on immigration as well as on foreign direct investment." There were no signs of any slowdown on the horizon, he said.
Much of the inflation was due to factors such as the 50p rise in cigarette prices, oil prices and the euro's low value, he said. Some of the pressure would ease when the exchange rate began to appreciate again, Mr O'Connell added.
According to Mr O'Connell, the euro was undervalued and would appreciate significantly. "The current exchange rate does not reflect the improved economic environment," he said. The current low interest rates did not suit the Irish economic environment but as a State which only makes up 1 per cent of eurozone GDP this is to be expected.
Mr O'Connell also stressed that the euro has been "fairly resilient" at around $0.90 even after the US authorities hiked rates by a half percentage point and the European Central Bank held rate steady yesterday.
Mr O'Connell said the euro remained steady which must be a "good sign".
According to market analysts, the lack of movement is only postponing the inevitable. According to Mr Pat O'Sullivan, economist at AIB, interest rates are likely to rise to 4 per cent in June.
However, he warned that if the US economy did not start to slow and the equity markets stabilise, the dollar could rebound again. The Central Bank is also concerned about house prices and about the high rate of credit growth in the economy. Credit which has been growing between 25 per cent and 30 per cent compared with a euro-zone average of around 10 per cent. If this continues the Republic will become "the most borrowed of the lot" Mr O'Connell warned. However, there is little the Bank can do beyond "stress testing" the banks to make sure they would be able to cope in an economic downturn.
However, Mr O'Connell said he did not see any evidence of a downturn in the economy generally or the housing market.
Labour Party finance spokesperson, Mr Derek McDowell, said both the Minister for Finance and the Taoiseach had previously responded to others articulating similar concerns as the Governor calling them "leftwing pinkos" and "creeping Jesuses. "Are they going to do likewise on this occasion?" he said. Rising inflation threatens to undermine the new Programme for Prosperity and Fairness, he said. "It already outstrips the social welfare increases given out by the Minister on Budget day. Make no mistake, it is a serious economic issue," he said.
