The economy grew by a record 11 per cent last year, but growth will slow this year as the Republic is affected by the international slowdown, according to Mr Jim O'Leary chief economist at Davy Stockbrokers.

Writing in Davy's quarterly Irish Economic Update, he warns competitiveness will be eroded gradually as the economy hits capacity restraints and our desirability as a destination for foreign direct investment wanes somewhat.

Davy has increased its forecasts for growth once again for last year. Mr O'Leary says 1998 was the strongest year of growth in recent times with GDP growth of 12 per cent and GNP growth - the main measure of economic activity - at 11 per cent. This would outstrip the previous 9.6 per cent GNP growth recorded in 1995, the highest of recent times. It would bring the cumulative growth rate of the economy to 51 per cent between 1993 and 1998, on the basis of GNP.

The slowdown in the world economy will be the main reason that the economy slows down this year, according to Davy. A fall-off in demand from our main markets, particularly Britain and some slowdown in foreign direct investment will both feed into this. In 1999, Mr O'Leary is now predicting GNP growth of 7.5 per cent and GDP growth of 6.3 per cent, with high consumer spending supporting consumer activity.

At the same time, the inflation rate is forecast to fall to 1.9 per cent and, excluding mortgages, could be even lower at around 1 per cent, according to Mr O'Leary. Overall domestic demand will spur on the economy while slowing export growth will be a mild deterrent, he says. The Exchequer finances will remain in good shape, Davy forecasts, and the debt to GDP ratio will end the year at 50 per cent, down four percentage points, as receipts from the sale of Telecom Eireann and ICC Bank flow into the Exchequer's coffers.

Mr O'Leary is also predicting that the Exchequer surplus of revenue over spending at the end of the year will be about £200 million (#254 million) higher than the Government is predicting, reaching £1.1 billion.

The biggest areas of restraint in the economy, according to Mr O'Leary, are in the labour market, physical infrastructure and in the housing market, where problems are still escalating.

The most important factor, Davy argues, is infrastructure where the gap between what we have and what the economy needs is widening. Even the large increase in capital spending announced in the Budget will make hardly an impression, he says.

The problem is most serious in transport and there is no way the Government can spend enough money to make a big enough difference. Money will have to come from the private sector, perhaps with more energy being put into public private partnerships.

Mr O'Leary advocates introducing charges for water, sewage, waste disposal, road usage and so on.

Davy has also changed its policy on tax cuts. According to Mr O'Leary, low levels of unemployment at around 7 per cent weaken the case for tax cuts to improve labour market functioning. "There is little voluntary unemployment at these sort of levels and different sorts of intervention are required," he says.

While, over the medium term, tax cuts are a good way of increasing labour supply according to Mr O'Leary, other problems may be urgent including the deteriorating infrastructure and, of course, house prices.

House price rises of around 35 per cent last year act as a greater deterrent to labour supply, particularly people coming back than taxation rates, he added.

Despite the Bacon proposals, Mr O'Leary says house prices are likely to continue growing by about 10 to 15 per cent a year over the next few years.