THE EUROPEAN Commission warned of “considerable risks” to Ireland’s economic outlook as it cut its forecast for growth this year to 0.6 per cent of gross domestic product, one-third lower than its prior forecast in November.

Saying economic activity continues to be weighed down by the aftershocks of the real estate bust, the EU’s executive branch noted that the export-led recovery would bring only a “very gradual improvement” in employment.

The forecast for unemployment was revised upwards to 14.5 per cent, as the “stabilising mechanisms” of emigration and lower participation have not proved as strong as anticipated.

“Of course growth and jobs are now a real challenge for Ireland and in terms of growth I think it’s important that export growth and industrial production are showing positive signs,” economics commissioner Olli Rehn told reporters.

He said the Government’s “jobs initiative” would support this tendency and added that the new rescue plan for the banks was a critical step forward in the drive to rebuild confidence.

“It is very important that Ireland was able to conclude the bank stress tests in a convincing way and in parallel decide on the restructuring and recapitalisation of its banking and financial sector in line with the EU-IMF programme.”

However, Mr Rehn’s spring economic forecast said it may take “some time” before new lending activity resumes in earnest.

This would result in a slower pace of investment in the economy, crucial because a domestic upturn was “conditional on the ability of a viable banking sector to extend credit”.

There was further uncertainty over the speed and force at which the “strongly positive effects” of fiscal consolidation would kick in, eventually supporting domestic demand. The forecast also said the outlook for interest rates would also have an important bearing.

“A key risk is represented by the elevated sensitivity of household disposable income to developments in interest rates, from both the European Central Bank and heightened risk premia in the euro area periphery per se.

“The large exposure of Irish households to mortgages on short-term rates means that the effect of the pass-through of higher interest rates on private consumption could be substantial.”

Although higher market interest rates posed a risk of higher interest expenditure, the forecast said a lowering of the “margin” on EU bailout loans would work in the opposite direction “At the same time, a faster-than-assumed pace of sectoral adjustment might provide support to consumption and investment demand.”

The forecast for 0.6 per cent GDP growth contrasts with November’s forecast of 0.9 per cent. In spring last year, the commission predicted GDP growth in 2011 would be 3 per cent.

The latest forecast assumes GDP growth will hit 1.9 per cent next year, “very modest” by historical standards in the view of the Commission.

“This reflects the drawn-out adjustment process, during which domestic demand is expected to continue to act as a drag, while exports should continue to drive the recovery,” it said.

A high household saving rate was forecast to decline only gradually this year and next.

The plans to restore the public finances to health were “ambitious but realistic”, the forecast said.

“In 2011, gross public debt is projected to reach 112 per cent of GDP, including capital injections into banks of €19 billion (12 per cent of GDP) with a net debt-increasing effect of around 6 per cent of GDP, as part is covered from Irelands own resources.”

The gross-debt-to-GDP ratio rose to 96 per cent in 2010 from 66 per cent in 2009.