Inflation could be set for a drop beneath 3 per cent before the end of the year following last month's surprise decline to 3.7 per cent, commentators said yesterday.

Data released by the Central Statistics Office show that the April fall in annual inflation, from 4.3 per cent to a three-and-a-half year low of 3.7 per cent, was driven largely by external factors such as declining energy prices and the falling dollar. Rising costs in the same month of 2002 also contributed to the overall percentage decline.

Economists say the slide will continue over coming months, particularly if current exchange rates are maintained and if, as many expect, the European Central Bank (ECB) moves to further reduce euro-zone interest rates.

This prospect became more real yesterday when the ECB revised down its growth forecasts for the euro area by about three-quarters of a percentage point to between 0.4 and 1 per cent for 2003 and between 1.1 and 2.1 per cent for next year.

The bank said average euro-zone inflation would rise no higher than 1.9 per cent in 2004 and could be as low as 0.7 per cent, giving rise to speculation that another interest cut could be expected.

The forecasts came as economists from Davy Stockbrokers reduced their growth expectations on the Irish economy, predicting that gross national product (GNP) would grow by just 0.8 per cent this year.

Davy expects inflation to fall beneath 2 per cent by the start of 2004, warning that next year's budget could be the toughest since the late 1980s.

The broker highlights the Republic's housing market as one of the most serious threats to growth, noting that "worrying signs of excess supply" can be seen in falling rents and rising vacancy. This will lead to a reduced role for "buy-to-let" investors, according to the analysis.

Davy said that April's inflation numbers proved that a "disinflationary trend" had begun in earnest and suggested that a fall to an average of 2.5 per cent towards the end of the year was possible.

Agreeing that a move towards 2.5 per cent was likely, IIB Bank chief economist Mr Austin Hughes said the downward momentum came as part of a global move towards lower inflation rather than a domestic trend, with the Government continuing to contribute about 1.8 per cent to the current annual rate.

Commentators called on Government to pursue an anti-inflationary path yesterday as the April figures showed domestic price pressures continuing to bite.

Employers' lobby IBEC welcomed the fall in average price growth but said inflation remained a major problem when compared to the Republic's competitors.

The Labour Party also welcomed the decline but said it should not allow the Government to think it is "off the hook" on the inflation problem. Fine Gael labelled the Government "the last refuge" for inflation, while the Green Party said April's decline had more to do with the dollar than Government efforts.