The Central Bank is forecasting a sharp slowdown in the Irish economy next year, with growth rates expected to tumble to 3.5 per cent or even lower - depending on the strength of a recovery in the world economy.

Central Bank assistant director general, Dr Michael Casey, said 3.5 per cent was its most optimistic growth forecast.

He added that the actual out-turn could be as low as 2 per cent if international economic conditions remained weak.

Dr Casey pointed to the confidence of the US administration that interest rate cuts and its expansionary economic policies would kick-start the world's biggest economy in 2002, and suggested that weak economic growth rates could be a temporary phenomenon here.

"There will be a marked slowdown, but not a recession. We will be able to get back to achieve our long-term potential growth rates of 5 per cent fairly quickly," he said yesterday.

In its winter bulletin, the Central Bank estimates that the Irish economy grew by 5.5 per cent in 2001, declining from 10.5 per cent in 2000. The economy continued to grow relatively strongly in the first half of 2001 but was stagnant in the last six months, according to the Central Bank.

"A resumption in growth in the Irish economy is substantially dependent on a recovery in growth in the international economy.

"An improvement in export demand would kick-start growth and contribute to domestic demand," the bank stated.

The bank does not have a definition for what constitutes a recession which, in the US, is the term used to define two consecutive periods of negative economic growth.

Dr Casey stressed it was important that people did not lose confidence in the Irish economy, pointing to historically low interest rates and the many structural reforms that have been achieved which will continue to support economic growth in the future.

The bank is forecasting relatively modest increases in unemployment, stating that even in the worst-case scenario of prolonged stagnation, unemployment could rise from current low levels of 4 per cent to 6 per cent. In this uncertain environment, the Central Bank said different sectors would be prone to diverse shocks, cautioning that flexibility in wages and other costs of production were necessary to cope with these developments.

It notes the increasing degree of wage flexibility in the Irish economy in recent years, and warns it is important that the evolution of public sector pay has due regard to Exchequer resources and to the need to avoid excessive inflation in the more sheltered sectors of the economy.

"The process of structural reform which the authorities have pursued over the past decade or more will stand the economy in good stead in coping with more difficult times," the Bank stated.