The Irish economy is performing more in line with Britain than the rest of Europe, according to the European Monetary Institute (EMI).

In its annual report, the EMI, the forerunner of the European Central Bank, said only two countries needed to raise rather than cut interest rates last year.

In its fourth and last report before it turns into the ECB on Monday, the EMI linked Ireland and Britain as two economies whose strong growth necessitated "a divergent approach" because of heightened inflation risks.

The institute said the exceptionally strong performance of the Irish economy, with buoyant money and credit growth, tightening labour market and rising asset prices, continued unabated.

It added that associated inflation risks prompted last year's interest rate rise, which brought the Central's Bank short-term facility rate to 6.75 per cent.

The report also points out that interest rates and exchange rates have converged in most countries; and in several others, interest rates have been reducing towards core European levels. Ireland and Britain are the only exceptions.

The problem for Ireland, which Central Bank Governor, Mr Maurice O'Connell, identified earlier this week, is that we do not want lower interest rates, but nevertheless they must fall significantly by the end of the year.

According to Dr Dan McLaughlin, chief economist at ABN Amro, the problem is that our devaluation shortly after Britain in 1992 and 1993 gave the economy a significant stimulus and pushed both economies ahead of the European growth cycle.

"This is one of the arguments used by the UK not to join monetary union. It is also singularly inappropriate for Ireland, but we are going ahead for political reasons."

In an effort to limit the inflationary impact of the rate cuts and booming economy, nearly all outside agencies from the Bundesbank to the European Commission to our own Central Bank have recommended holding back on tax cuts and on spending. Mr Wim Duisenberg, president of the EMI and president-elect of the ECB, repeated yesterday that it was imperative that all member-states should re-establish budgetary flexibility.

He warned it would be essential for countries to maintain price stability and to ensure the emerging common level of short-term interest rates was consistent with price stability in the whole area.