Recently, I had a telephone conversation with an English economist on the success of the Irish economy. In our discussion of the whole Celtic Tiger phenomenon, it quickly emerged that this economist was very much a sceptic. In my efforts to establish that the boom had not been an elaborate smoke-and-mirrors trick, I referred to data from Eurostat, the EU's statistical agency, which states that the Republic's income per head is second in the EU after Luxembourg. While this result is partly due to the distorting effects of multinational transfer pricing, the Republic has clearly overtaken the UK (whose GDP per head is slightly below the EU average).

This information was received with a long and rather awkward silence. I might as well have said, "Eurostat data shows that the moon is made of blue cheese." For him, the possibility that the Republic has become a richer economy than the UK was too fantastic to believe. The land of humpback bridges and Guinness couldn't be richer than the UK and it was impolite to suggest that it might be.

Of course, this blinkered view is far from being universal. Most in the City are happy to accept that the Republic's era as the poor man of Europe has well and truly passed. Moreover, it is slightly hypocritical to fault English scepticism, as it is often surpassed by Irish misgivings. I have had countless conversations with relatives and friends in which they say that the economy is about to go bust while I try to reassure them that it is not. While eternal scepticism is an interesting aspect of the Irish psyche, the scepticism within financial markets is more than just an intriguing detail - it has very real effects. This scepticism has grown in recent months - for little discernible reason - and it has been a principal cause of the recent poor performance of Irish equities. A few short months ago, the rapid growth prospects of the Irish economy were seen as a reason to buy shares in Eircom and in Irish banks; now the exposure of these companies to the economy going "bust" is one factor driving share prices lower. There are a couple of reasons for the scepticism.

First, the Irish Central Bank has fostered doubts to dampen domestic euphoria and (hopefully) prolong the good times. It is widely appreciated that the symptoms of overly optimistic expectations - such as rapidly accelerating wages - would cut the Republic's success prematurely short. The Central Bank does its best to prevent this by consistently producing reports which warn of overheating while talking of slowing growth. It has been producing similar reports for the past four years and did so again last Tuesday. While you can't blame it for doing this (it's what my religion teacher in primary school would have described as a "white lie"), neither should you believe that the risks are as bad as it suggests. However, overseas financial institutions depend on the reports and Central Bank statements as they rarely have a specialist to cover the Irish economy.

Irish politicians also downplay the economy's success. Doing so strengthens their hand in negotiations in national wage agreements. Furthermore, it has helped Irish governments in negotiations with our EU partners over structural funds. The longer the Republic appeared "poor", the longer the subsidies kept flowing. To quote The Economist, Irish politicians have been "modest fellows, no doubt; shrewd as well".

A more substantial reason for the scepticism over the Republic's prospects is that the fears are not entirely without substance. The growth rates of 810 per cent since 1994 are unsustainable. The OECD estimates that the potential growth rate (which is a function of productivity and labour force growth) is between 5 and 6 per cent. Growth rates over and above that in the past six years were possible because unemployment was so high in the early 1990s. Now that the unemployment rate has fallen to 6 per cent, the potential for continued above-trend growth is reasonably limited.

But to say that the boom will not last forever is not to say that it will end in bust. Over time, rising costs - in particular, wage growth - will undermine the Republic's attractiveness for overseas and domestic investors. Moreover, labour-intensive/low-skill industries which located in the Republic at a time when wages were among the lowest in Europe will be tempted elsewhere. Although there is a danger that this will happen abruptly if wages accelerate too sharply, evidence of excessive wage growth is limited to a small number of sectors. The most likely scenario is that declining investment will result in a slowdown in economic growth over one-two years but not a collapse. However, with a trend growth rate of 56 per cent - compared with 23 per cent for most industrialised countries - the Republic's relative performance will remain pretty impressive.

Irish equities are now cheaper - judged on their price-to-earnings ratios - than their European counterparts.

While this can partly be explained by the sector concentration of the companies in the ISEQ index, it also reflects fears over the future of the economy. Given that these fears are likely to prove misplaced, Irish shares look undervalued.

Kevin Daly is European economist with Credit Lyonnais Securities Europe.