Analysis: The institute is upbeat about prospects for the economy but does warn that the US deficit has the potential to upset the benign outlook, writes John McManus

A less sanguine view of the prospects for the dollar is reflected in the Economic and Social Research Institute's winter bulletin.

The think tank has revised up its prediction for the average dollar-euro exchange rate next year from $1.17 to $1.30.

The direct and indirect consequences of this for the Irish economy is in turn reflected in lower growth projections for 2005. Although the US economy will grow strongly next year, the impact of this on the Irish economy - in the form of demand for exports - will be tempered somewhat by the strong euro.

In addition, any fall off in Irish exports to the US is unlikely to be compensated for by demand from within the Euro area, given the static growth levels in the major European economies.

As a result, the ESRI is now predicting that Gross Domestic Product - the value of the goods and services produced by the economy - will grow by 5 per cent next year, down from the 5.4 per cent prediction made in the autumn.

The estimates for Gross National Product growth - which takes into account outflows such as US multinational profits - has been scaled back from 5 per cent to 4.6 per cent.

These levels are still close to what are seen as the longer term trend levels of the economy and the ESRI takes comfort from strong performance by domestic indicators - such as retail sales and mortgage credit - during the third quarter of 2004, when international growth rates were starting to falter. Employment growth will remain strong, but fall back from a record 2.6 per cent to 2 per cent next year.

In addition, a weaker dollar should have benefits if the form of cheaper US imports as well as providing a fillip to US investment in Ireland.

The disinflationary implications of the weaker dollar are the most beneficial consequence, but the stronger euro will in turn help keep down euro zone interest rates.

As a result, the ESRI is forecasting that inflation will remain relatively low at 2.1 per cent, but ahead of the ECB target rate of under 2 per cent. Oil prices are also expected to moderate next year which will put further downward pressure on inflation.

The main threat to this relatively benign outlook is the structural imbalance in the US economy, which is currently running very large current account and budgetary deficits.

The ESRI believes that the resolution of this will not be possible with a fall in US consumption, which in turn will hit global economic growth.

In the short term, any further weakening of the US dollar is likely to have negative impact.But short term respite might come in the form of a revaluation of the Chinese currency, which is one of the causes of dollar weakness.

The other issue identified by the ESRI is the dependence of the economy on housebuilding as a source of domestic growth. The record level of house completions seen last year, accounted for around 1 percentage point of the 5.1 per cent increase in GNP expected this year.

A dramatic fall off in this activity would make a significant dent in growth next year, argue s the ESRI. But it acknowledges it would take some form of severe regulatory intervention - such as tax on second homes - or retrenchment in the economy to bring this about.

Given these two threats, the ESRI argues that the moderately expansionary stance adopted by the Government in the recent Budget may not be a bad thing. The package of tax cuts and expenditure increases announced on Budget day will be stimulatory for the economy at this point in its cycle, it concludes.

As a consequence the General Government Balance will move from a surplus of 1.1 per cent of GDP to a deficit of 0.6 per cent next year.

Debt, as a percentage of GDP will fall below 30 per cent, its lowest level in 30 years.

On balance, the ESRI is upbeat about the outlook for the economy and points out that current growth levels are exceptional, given the international setbacks that have manifested since the start of the decade.