Economists believe inflation could be as low as 3 per cent to 4 per cent by the end of the year, following the first decline in the annual rate since July 1999.

Figures released by the Central Statistics Office yesterday showed that the consumer price index fell back in December to below 6 per cent. Prices rose by 0.1 per cent during the month, with annual inflation falling to 5.9 per cent compared to a 16year high of 7 per cent in November. The next set of data - for January - is expected to show a further decline to a little more than 5 per cent.

The employers' organisation, IBEC, said cool heads were needed to ensure that domestic sources of inflation were managed.

"Average inflation for 2001 will be very much below the 5.6 per cent average for last year if shortsighted wage claims above the renegotiated PPF are resisted - by all sides. Such discipline is necessary to maintain stability and protect jobs."

The Irish Congress of Trade Unions said close monitoring of prices must be maintained to ensure that reductions continued to be passed on to consumers.

Price rises slowed last month as a result of cuts in the cost of petrol, falling oil prices and no further increases in the cost of cigarettes. The annual rate of inflation for the whole of 2000 was 5.6 per cent, a sharp increase on the previous year when the annual average was 1.6 per cent.

Inflation is now at its lowest since June of last year, with core inflation excluding mortgages at its lowest since last January at 4.7 per cent.

Analysts expect inflation to continue falling this month as the retail sales and mortgage cuts affect the figures. According to Mr Jim O'Leary, chief economist at Davy Stockbrokers, it will be running around 5.3 per cent or 5.4 per cent, with core inflation, excluding mortgages, at 4.2 per cent or 4.3 per cent.

Mr Colin Hunt, chief economist at Goodbody Stockbrokers, is even more optimistic, predicting a fall to 5 per cent this month and to around 3 per cent by the end of the year.

Economists had predicted the fall, which is the result of the tobacco price rise implemented in December 1999 dropping out of the equation as well as mortgage rate increases in the same month. Inflation is likely to fall further over the coming months as the strengthening euro keeps the costs of imports steady and oil prices continue to hold steady or fall a little.

On an EU harmonised basis, price rises were down 0.1 per cent in December and inflation was running at 4.6 per cent from a year earlier, down from 6 per cent last month. The corresponding rate for the euro zone as a whole was 2.9 per cent in November.

A 3 per cent fall in energy prices, which knocked almost 0.3 per cent off the index, was offset by price rises for food and consumer durables. Higher prices for beef, lamb, potatoes, fresh vegetables, fresh fruit, milk, bread and meals out added to the pressures.

Mortgage interest rates also pushed the index up slightly. Over the month house prices rose significantly at 0.6 per cent. Transport costs fell with a decrease in the price of motor fuels, partly offset by a rise in motor insurance.

The price of drink and tobacco were both unchanged in December.

Over the past year the rise in the cost of housing at 26.2 per cent, has increased most significantly as mortgage interest rates and rents have risen. Fuel and light is up 10.4 per cent while transport is up 6.4 per cent reflecting higher oil prices over the past year. Clothing and footwear prices in contrast are down 4.8 per cent over the past year.

The Government Chief Whip, Mr Seamus Brennan, welcomed the reduction in inflation. He said the positive effects of the Government's actions in the Budget would be reflected in further reductions in inflation over the coming months.

However, Fine Gael finance spokesman Mr Michael Noonan said the reduction in inflation was more apparent than real. "The recent Budget was inflationary. While the Government's changes in VAT and excise will exert some downward pressure, the underlying inflationary trend is upward. The cost of most services continues to rise and there seems to be no relief for the hard-pressed consumer who is very conscious of the rising cost of living."

SIPTU general president Mr Des Geraghty and ATGWU leader Mr Mick O'Reilly cautioned against complacency on the part of the Department of Finance and the Government.