Wage growth should be stemmed to protect the economy's growth capacity, the Central Bank warned yesterday.

The Central Bank's new governor, Mr John Hurley, has called for a "sensible" approach to pay as the Government prepares for the benchmarking review of public service pay and negotiations on a new social partnership agreement.

With the public finances showing Government expenditure increasing more than tax receipts, Mr Hurley also called for a "neutral" fiscal stance.

It was too early to project year-end tax figures, but Mr Hurley said the initial income tax receipts were "disappointing". Other taxes were "strong enough", he said.

Mr Hurley said the Central Bank would report this week to the Minister for Finance, Mr McCreevy, on the sufficiency of its regulatory powers in the light of the Allfirst fraud at AIB.

The Central Bank had already indicated that it would not sanction AIB and expected all other Irish banks to conclude reviews of their control systems within months.

In relation to pay, Mr Hurley said: "I think that prudence and careful management would pay very major dividends going forward."

Stating that inflation was the most significant threat to economic expansion, he said wage growth threatened the capacity of the economy to create new jobs and sustain those that were already there.

Indigenous Irish firms were less competitive than multinationals, he said.

However, Mr Hurley stressed that he was also concerned about higher prices for services and utilities, which were feeding into inflation.

Combined with wages, such pressures had greater potential to damage the economy because an 8 per cent appreciation in the euro had the potential to contribute to inflation, he said.

He added: "I would have concern with a very large and sudden appreciation in the euro."

At a briefing to publish the Bank's 2001 annual report, Mr Hurley said he believed gross national product would grow this year by 3 per cent.

This contrasted with growth of 5 per cent in 2001 and 10.4 per cent a year earlier, before the downturn began. But while Mr Hurley said there was potential to expand by 4.5 to 5 per cent per year after 2002, the timing of such recovery would depend on domestic policy and international developments.

He said: "My focus going foward is to reach that level of growth. I'm looking for carefulness and prudence and if we approach it that way, we can achieve that level of growth. If we're careful going forward and if the global economy recovers, there could be more than doubling the level of growth.

"We learned hard lessons in relation to employment in the past. We need to be very careful not to lose momentum now."

Asked whether he was concerned about a wages free-for-all developing, Mr Hurley said social partnership had served the economy very well.

Negotiations between the Government, employers and the trade union movement on a new partnership agreement are expected to begin in the autumn.

Mr Hurley was reluctant to speculate on the outcome of the report of the State-appointed Benchmarking Body, which is comparing salaries in the public sector with private-sector pay.

To be completed at the end of the month, the report is expected by some observers to highlight large gaps between the salaries earned by workers in the two sectors.

Mr Hurley said: "As an analysis, it's going to be a very important piece of work. The outcome will be for negotiation."