The Central Bank yesterday urged the Government to maintain robust public finances so that they can be used as a "buffer" in the event of a significant slowdown in the economy.
A "sharper than expected" decline in the housing sector and loss of competitiveness remained "vulnerabilities" for the economy, the bank said as it released its annual report for 2006, while a weakening dollar and high oil prices were also posing risks.
However, the bank stressed that the outlook for the next two years remained positive, with the economy still on track to grow by 5 per cent this year and 4 per cent in 2008; growth rates which compare well with other economies.
While Central Bank governor John Hurley believes the housing market is most likely to make a soft landing, a more dramatic fall in house building "cannot be completely ruled out", he said.
Mr Hurley said that it would be "completely counter-productive" for employees to seek higher wages as compensation for higher mortgage payments.
It was important to "maximise flexibility in the economy" in order to cope with any unanticipated slowdown in the economy, he said.
"One element of this is maintaining a strong fiscal position and thus providing a buffer in the public finances, which will help any adverse developments to be absorbed," he added.
This would make it easier to avoid "remedial fiscal measures" and facilitate a quicker rebound in the performance of the economy should growth be "somewhat reduced".
Investment in infrastructure, more research and development activity and increased productivity and efficiency on the part of public and private enterprises are among the ways to reverse the recent deterioration in competitiveness, Mr Hurley noted.
The governor said it was "impossible to quantify" the risk to the economy posed by the weak dollar, which yesterday fell to a record low against the euro.
The Irish economy is "particularly exposed" to oil price volatility because of our high dependence on imported oil as an energy source.
The Central Bank welcomed the slowdown in the growth of credit in the economy and said the recent falls in house prices were "more consistent with stability" than the price rises recorded this time last year.
It forecasts that 80,000 houses will be built this year and 77,500 in 2008 but noted that, in the long term, the economy only needs 60,000 new houses each year.
More construction firms reported vacancies in June compared with May, according to a survey published yesterday by Fás and the Economic and Social Research Institute.
But a higher proportion of employers in the sector still expect the number of jobs to fall rather than rise over the coming months.
Although figures for the early part of 2007 suggest that economic growth is exceeding 5 per cent, the slowdown in house building and more moderate rates of consumer spending will dampen economic growth as the year continues, the Central Bank said.
Consumer spending will also grow at lower rates next year as the impact of money maturing from Special Savings Incentive Accounts fades.
The Central Bank has revised its forecast for consumer price inflation for next year to 3.75 per cent, up from 3.5 per cent.
The bank's forecast for 2007 is that inflation will be 5 per cent, which is well above the European average.
