The European Commission has warned of the inflationary dangers in the Irish economy and has suggested that a tighter fiscal policy "would be more in keeping" with recommendations agreed by finance ministers last year.

However, the Commission reported yesterday that Ireland had comfortably met its obligations as a member of the euro-set and acknowledged the dilemma faced by the government in cutting income tax further.

While the requirements of the Stability and Growth Pact are compulsory for euro-members - particularly the emphasis on maintaining the deficit below 3 per cent - the broad economic guidelines agreed by finance ministers in 1999 are not.

The Commission was conducting its annual assessment of five member states' compliance with the Stability and Growth Pact and in the case of non-euro countries their compliance with agreed Convergence Programmes. The Commission's recommendation goes to finance ministers for approval on January 31st.

The Commissioner for Economic Affairs, Mr Pedro Solbes, refused to be drawn into direct criticism of the Government's Budget strategy, acknowledging that there was a real "dilemma" facing Irish policy-makers.

"If you reduce taxation it could have additional effects on demand and could create inflation," he told journalists. "And on the other hand it is true that reductions in taxation can be positive on the supply side analysis of the economy. It's a difficult decision and I hope that the Irish authorities will be able to find a reasonable balance." He said that Ireland, in its implementation of the 1999 Stability and Growth Pact, "exceeded expectations", comfortably fulfilling its obligations and that the updated programme adheres to the strategy that has brought the successful catching up in the Irish economy.

"The strategy reflects a broad social consensus and combines a credible commitment to macro economic stability with wide-ranging structural reforms. The macro economic programme presented in the programme is plausible. However, there is a significant inflation risk if the expected economic slowdown fails to materialise."

The continued strength of the Irish economy will be reflected in substantial general government surpluses and a declining debt ratio.

The report to the Ecofin will say that in 1999 Irish GDP grew by 8.4 per cent, 1.75 percentage points faster than expected. A Government surplus of 3.2 per cent for the year is predicted while the debt to GDP ratio will fall to 52 per cent.

It predicts that inflation will fall by 2002 from 3.4 to 2.7 per cent, before converging again with the euro-zone average. The report warns, however, of the dangers of higher inflation in 2000 and says that wage drift under the Partnership Pact should serve as a warning.

Government debt to GDP is projected to fall to 36 per cent by 2002 and government expenditure is set to fall by three percentage points to 29 per cent of GDP. The tax burden will drop by a further one per cent to 31 per cent of GDP.