The economy is showing increasing signs of overheating and underlying inflation is likely to remain significantly above the euro zone average for some time, the Central Bank has warned in its latest bulletin.

Consumer price inflation is likely to increase further in the months ahead but the Bank is still forecasting an average rate of 4.75 per cent this year.

However, it added that inflation at the end of the year is likely to be close to or perhaps below this figure. This contrasts with its forecast at the publication of its annual report last month when it said that inflation would be closer to 4 per cent at the end of the year.

In common with the Government, it is forecasting a slightly lower rate of about 3.75 per cent next year, assuming the effects of the weak euro and higher oil prices fade.

The Bank, in its summer bulletin, says that rising inflation is being reflected in accelerating wages, rapidly rising asset prices, high rates of growth in money supply and credit and increased congestion in the physical infrastructure.

Rising wages will also erode competitiveness, the Bank warns. "While a loss of competitiveness may be avoided this year due to the weakness of the exchange rate, the increasing disparity between wage developments here and in our main trading partners leaves the economy increasingly vulnerable in the event of a negative demand shock or a reversal in the exchange rate trend."

The bulletin points out that the rise in inflation is accounted for by a combination of high oil prices, a decline in the value of the euro and domestic factors such as higher excise duties and increased services sector inflation.

According to the Bank's calculations the greater exposure of the Irish economy to the weak euro accounts for 0.5 of a percentage point of the inflation rate; about 1 percentage point can be explained by the higher productivity in the traded sector than elsewhere. The remaining inflation differential of about 1.5 of a percentage point reflects strong domestic demand considerations, according to the Bank.

The bulletin also points out that interest rates are still very low for Ireland despite the 1.75 percentage point increase since November 1999. According to the Bank, this rise was welcome because of the relatively strong growth and high inflation here compared with other countries.

It also warned that labour market pressures are likely to intensify and there will be further upward pressure on wages. The increasing labour shortages will begin to limit output growth and will slow up economic growth going into next year.

According to the Central Bank's latest predictions, the economy or Gross National Product will rise by 8.5 per cent this year and is unlikely to fall below 7 per cent next year. At the same time, consumer spending is likely to grow at 8.5 per cent despite the effects of a higher level of consumer price inflation.

It is also predicting that the rate of unemployment will continue to fall, although at a slower rate. It is expecting an average rate of around 4.5 per cent this year.

The labour force expanded by 5 per cent in the first three months of 2000 following growth of 5.2 per cent in the previous quarter. According to the Bank this reflects higher participation rates, particularly among women, the natural increase in the population of working age and continued net inward migration.

The Bank is also predicting that the balance of payments surplus, or balance of exports over imports, recorded last year will be replaced by a modest deficit this year.