Interest rates may drop significantly in May, then slide further to leave short-term rates almost three percentage points below current levels by the end of the year, the Central Bank has indicated.

The bank also warned that the housing market could be heading for a "speculative bubble" and that inflation remains a concern.

Speaking at the launch of the bank's Spring Bulletin, Mr Peter Charleton, head of monetary policy at the bank, said: "There is a distinct probability that interest rates will fall quickly in May."

He added that it was difficult to prejudge the pattern of the fall but they would probably come down quite quickly.

The catalyst for the fall will be the setting of the level at which ERM currencies will tie into monetary union. This decision, along with the one on which member-states will join, will be taken on the first weekend of May.

There has been a lot of debate in financial markets about the timing of the interest rate falls, with many believing that the bank would do its utmost to keep rates high for as long as possible.

Dr Michael Casey, assistant director general at the bank, insisted that rate cuts are up to the money markets. "We want to hand over the baton as smoothly as possible to the European Central Bank and are taking a neutral approach to rates. If the markets want to bring them down, that is fine."

While the precise speed of rate cuts cannot be predicted, it is certain that Irish rates will be at German levels by the end of the year - and at the moment that is only 3.3 per cent. This is almost three percentage points below the current level of Irish short-term rates.

However, some economists dismissed the idea that the bank would, in reality, cede control to the markets. "They call the shots. But I do think May will be a watershed and there will be a substantial cut. It may be one percentage point with the balance in steady steps over the balance of the year," according to Mr Jim O'Leary, chief economist at Davy stockbrokers.

Dr Casey also insisted that there were signs of pressure on inflation. The bank is now expecting inflation to average 2.75 per cent to 3 per cent this year. That would point to a peak of around 3.5 per cent at the end of the year, given the current low level of price rises.

The bank is worried that the pound's recent falls against most other currencies will feed through to higher import prices and then prices in the shops.

The other inflationary danger is from accelerating house prices. Dr Casey warned that house price rises are getting close to a "speculative bubble" where prices simply feed on each other. "Bubbles have a habit of bursting," he noted.

The main cause for the bank's concern is the high number of investors now buying residential property. About 30 per cent of all homes are now thought to be bought by investors and that is often thought to be a sign of a bubble.

Nevertheless, the bank insists that, so long as the retail banks keep to conservative lending multiples, there should be no problem. The bank has revised down its forecast for growth in the economy this year, primarily because of reduced consumer spending power as inflation picks up. It is now expecting gross national product to rise by 6.5 per cent.

It is also expecting employment to continue growing strongly, albeit at 3.25 per cent this year from 4 per cent in 1997.