The Central Bank has warned of increased uncertainty in the international economy, saying investors' pursuit of higher returns could lead to financial sector risks.

Although the Bank says in a new report that the outlook for the Irish economy has improved, it finds the global outlook has weakened amid concern that the slowdown in the Chinese economy is worse than anticipated.

Saying high national and household debt makes Ireland vulnerable to economic shock or higher interest rates, the Bank adds that high indebtedness acts as a drag to consumption and investment.

The Bank’s assessment is made in its Macro Financial Review, a twice yearly examination of conditions underpinning the financial system and financial markets.

The document, published this morning, says Ireland’s gross domestic product is forecast to expand by 4.7 per cent in 2016 after 5.8 per cent growth in 2015.

“Stronger domestic demand is evident, supported by an improving labour market and rising real wages which benefit the household sector directly,” it says.

“The non-financial corporate sector is seeing strong growth in exports, while investment is forecast to rise sharply in 2015 and 2016.”

However, such developments occur against a backdrop of an uncertain international macroeconomic and financial environment.

“The performance of the Chinese economy and its financial markets have been in the spotlight in recent months, with a decline in growth now appearing to be more pronounced than previously anticipated,” it says.

“In the euro area, output growth remains moderate and both headline and core inflation rates are subdued, reflecting, in part, lower commodity prices.

“Persistently low inflation and muted nominal growth are not supportive of debt sustainability in euro area sovereign and corporate sectors.

“Financial sector risks could materialise as a result of the global search for yield that is being observed in financial markets. In an environment where official interest rates are very low, investors have been seeking better returns across investment classes.

“A risk to financial stability is the potential for excessive risk-taking by investors. A rapid decline in asset prices is possible if investor sentiment changes, a rise in official interest rates occurs, or some adverse economic or financial event arises.

“Low levels of secondary market liquidity, particularly in fixed-income markets, could exacerbate adjustments.”