The Government must use next month's Budget to stop the economy from overheating, the Organisation for Economic Co-Operation and Development has warned in its latest report. According to the OECD, tax cuts in the Budget must be offset by other measures which take money out of the economy and wage rises should be limited.

In its twice yearly Economic Outlook the OECD says the risks of Ireland substantially overheating are rising. Unemployment is set to fall to 5 per cent, wages are picking up steadily and house price are continuing to soar, it notes.

However, according to Mr Jim O'Leary, chief economist at Davy Stockbrokers, the advice from the Paris-based think tank is simply not practicable. It is not possible for the Government to restrain wage rises or to withhold tax cuts to the extent suggested and the spending horse "has already bolted", he said, with the estimates providing for further rises next year.

The OECD says the Government has "no choice" other than to use budgetary policy to limit domestic demand. In addition, income tax cuts should at least be offset by base broadening - levying taxes from new areas - expanded user fees and aggregate spending restraint, even allowing for desirable infrastructure outlays.

And in the negotiations for the new agreement the Government should not accede to demands which would mean rises out of line with our main trading partners. That would mean rises of around 2 per cent, which are unlikely to be acceptable to most trade union members.

It says the main risk is that wage and price inflation will both rise even faster with possibly a breakdown in centralised wage setting, leading to more overheating.

The OECD predicts the economy will grow at 7.6 per cent this year before moderating to 6.8 per cent in 2000 and 5.2 per cent in 2001.

The report says euro-zone interest rates should remain low until late next year.

In contrast it says a series of interest rate rises are needed in the US to avert what it believes could be a "hard landing" with potentially major consequences for the rest of the world. The report was written before last night's 0.25 of a point rise in US rates.

Overall across the OECD area the organisation is looking forward to resumed growth. The outlook has "improved substantially" over the past few months. It is now predicting that average growth will be around 3 per cent in 1999 and 2000 before slowing to 2.5 per cent in 2001. This is a cumulative increase of some 1.5 percentage points sine the last Economic Outlook was published in May.

This broadly reflects the continued momentum in the US economy, more rapid restructuring in Japan and Korea, and slightly better prospects in the EU.

At the same time it expects unemployment will edge down a little and apart for high inflation countries will remain below 2 per cent over the next two years. EU unemployment is likely to drop by 2.5 million between 1998 and 2001, the report states. Irish unemployment will fall from 5.8 per cent this year to 5 per cent in 2000 and 2001.

But there are risks. These include the large current account deficit in the US and fragile recoveries in Russia and Latin America as well as a possible derailing of the Japanese recovery.

But perhaps the most devastating would be a hard landing in the US. The OECD points to high equity prices and concerns about overvaluation. "Any sudden rise in US inflation would trigger an abrupt change in investor sentiment," the OECD warns.

It argues that the US has been growing at more than 4 per cent for three years in an upswing that began 8 1/2 years ago. In the near term, it continues to strengthen and is operating above potential, according to the OECD, while labour markets are very tight

All in all, a further tightening of monetary policy, probably in several step, is required. It sees the federal funds rate rising in steps to 6.5 per cent by the end of 2002 from the current level of 5.25 per cent. An important challenge will be to manage upward moves in such a way as to minimise risks of excess.