Analysis: the quarterly report says that the economy will pick up in 2005 and, in the meantime, developmental spending must not be ignored , writes Una McCaffrey

The economy is in the midst of a cyclical downturn and now is the time to prepare for the pick-up that will eventually arrive - sound advice as ever from the Economic and Social Research Institute (ESRI).

The think-tank is expecting the economy to move back towards trend growth of 4-5 per cent in 2005 but says that, for the moment, all the classic aspects of a downturn are in place.

Firstly, we have falling tax revenues, as evidenced by the €500 million hole forecast by the Department of Finance last week.

Secondly, inflation is dropping and is set to decline even further over the coming year.

Thirdly, and perhaps most crucially, unemployment is rising.

The ESRI is forecasting that 95,000 people will, on average, be unemployed at any given point this year, using the Quarterly National Household survey measurement, which excludes part-time and seasonal workers. In 2004, this will rise more than 100,000, according to the ESRI's latest quarterly commentary.

This will hit consumer confidence and, when combined with the prospect of rising interest rates, could damage the property market, the ESRI's economists believe.

They also see risks in the Republic's falling inflation rate, arguing that, although deflation remains a remote prospect, it could become a "real issue" if a deflationary trend takes hold in the rest of the euro area.

"The worst-case scenario for Ireland would be to experience deflation when the rest of Europe is experiencing price rises," the ESRI warns.

In such circumstances, monetary policy would not take account of Irish conditions and could reinforce deflationary trends, according to the commentary.

The ESRI has revised down its gross domestic product (GDP) forecast for this year from 3 per cent to 2.6 per cent and cut gross national product (GNP) from 2.5 per cent to 2.4 per cent.

The ESRI's economists differ from other commentators in the proximity of their GNP and GDP forecasts, with most others putting GNP lower and GDP higher to reflect the profit repatriations of multinationals operating in the Republic.

Trends evident in trade figures for the year to date suggest that the two will converge, the ESRI insists, admitting however that this forecast contains some "vulnerability".

Like most economic commentators, the ESRI sees the continuing strength of the euro, particularly against sterling, as the most worrisome issue on the Irish economic horizon.

And like many other observers, the ESRI says the economy needs to fight this with a faster and more effective implementation of competition policy.

However, Mr Danny McCoy, editor of the commentary, warns against treating competition policy and regulatory reform as "a panacea to bring inflation under control".

He says it should focus on future inflationary impulses rather than current prices.

Mr McCoy also warns that an "overly aggressive" implementation of competition policy when an economy is skirting deflation could lead to a price crunch.

The ESRI has once again urged the Government to spend with a view to the future too, arguing that loans should be taken out now, while interest rates are low and growth is at reasonable levels, so that coming generations will be provided with the infrastructure they will require.

Mr McCoy accuses the Minister for Finance, Mr McCreevy, of adopting a "pro-cyclical" policy on capital spending, whereby it has been tightened in line with a slowing economy.

He said this tendency has been driven by a desire to live within the Stability and Growth Pact, which governs monetary union.