The average cost of telephone bills will increase by up to 4.5 per cent next year if a proposal by the telecoms regulator to relax a price cap on Eircom is carried through.

The regulator, Ms Etain Doyle, yesterday issued a proposal that would enable Eircom to increase its prices from 2 per cent to 4.5 per cent from early 2003.

A rate of 4.5 per cent would increase the average monthly residential phone bill to about €52.25, compared to the current average of €50.

A price rise by Eircom in early 2003 would represent the first average increase in retail telecoms services for years and may put upward pressure on inflation rates.

Ms Doyle also removed a range of "sub caps" on a basket of Eircom's retail services in a move that will result in a big increase in line-rental costs - which are currently at €19.60 per residential phone line.

Eircom may also increase the cost of phone calls for the first time in several years, although this will depend on the level of competition in the sector. In the past three years, Eircom cut minimum calls charges to 6.35 cents per minute from 14.6 cents to help it compete with other firms. However, the fact that there are fewer competitors in the market may enable it to raise call costs.

At present, Eircom must reduce the price of a range of telecoms services by an amount set at a formula of the consumer price index (CPI) minus 8 per cent.

With the current inflation rate running at about 4.5 per cent this forced it to reduce prices by almost 4 per cent annually over the past three years.

But Ms Doyle's proposal yesterday has set a formula at a band between the CPI and CPI minus 2 per cent. This suggests price rises from 2 per cent to 4.5 per cent.

Eircom said yesterday it was disappointed by the regulator's decision to retain a retail price cap. "While we clearly welcome the decision to relax the formula, our view is that, given the crisis in the sector, a formula of CPI minus zero is essential to incentivise investment," a spokesman said.

The firm also expressed "very deep concerns" about the regulator's proposal to allow Eircom a rate of return of 11-12 per cent. Currently the firm is allowed a rate of return on investment of 12 per cent.

A reduction in this rate at a time of crisis in the sector would undermine its incentive to invest, an Eircom spokesman said.

It is understood the regulator included this proposal to ensure that Eircom continued its drive to become a more efficient operator.

Eircom rival Esat BT said it was also disappointed by the proposal because it had sought a deep wholesale price cap together with tough predatory price controls imposed on Eircom.

Indeed, most competing telecoms operators believe the price cap has undermined their business by forcing their main rival Eircom to reduce its prices, which in turn pressurises their own margins on calls.

The proposal by the regulator also includes details of a scheme to help the most vulnerable in society.

The regulator has set a deadline of January 10th for people to consult on the proposals. It is expected a ruling will be made by the regulator by March 2003.