The Government must limit its pre-election Budget giveaway to no more than a third of the spending increases and tax cuts delivered this year, the Economic & Social Research Institute (ESRI) has warned.

The economy is now at a turning point and the December Budget must reflect the new realities, ESRI economist Mr Danny McCoy said yesterday.

He suggested that the Government has room for spending increases and tax cuts of up to £700 million (€889 million) next year. That is substantially less than the £2.1 billion injected into the economy by the last Budget.

At the same time, the ESRI - in its quarterly bulletin - is predicting that wages will continue to rise quickly - by 10.8 per cent this year and by a further 9.5 per cent in 2002.

According to Mr McCoy, spending should be aimed at capital projects which will reduce problems such as traffic congestion and house prices.

Mr McCoy said that budgetary spending on health and education was a political choice but would require compensatory tax increases.

He warned that to increase spending or cut taxes by more than £500 million to £700 million would "fritter away" the fruits of growth in recent years. Economic growth is set to fall back further as a result of the impact of reduced demand from the world's major economies as well as large falls in IT investment.

It is estimating that growth will fall to 7 per cent in terms of Gross Domestic Product this year and 6.4 per cent next year. In terms of Gross National Product, it is expecting a 6 per cent rise this year and 5.4 per cent next year. Nevertheless, overheating remains, along with strong inflation and the first external deficit of imports over exports in eight years.

According to the ESRI, inflation will average 4.8 per cent this year as lower interest rates and lower import prices kick in.

However, the ESRI forecasts are based on a benign view of the US economy which it sees recovering towards the end of the year.