The December Budget should not include major tax reductions, as this would risk overheating the economy, the Central Bank has warned. Any reductions in income taxes should be matched by tax increases in other areas, it said in its latest report.
All the personal income-tax reductions promised in Partnership 2000 have been made in the past two years, the Bank says in its autumn bulletin, and any further reductions will provide a stimulus to an already booming economy.
"A generalised drift could lead to a bigger boom and a bigger headache seven years down the road," Dr Michael Casey, assistant director-general at the bank, warned at a briefing on the bulletin.
He said any personal income-tax cuts should be matched by tax increases in other areas. He added that the limits on Government spending in the Programme for Government must be seen as an "absolute ceiling". Buoyant Government revenues should be used to pay off the debt, not to increase spending.
Dr Casey refused to comment directly on the timing of the coming interest-rate cuts, which must happen by the end of the year as Irish interest rates fall to German levels. Short-term rates on the wholesale money market here are 2.75 percentage points above Germany and must fall to German levels by year-end.
However, Dr Casey hinted that the Bank will hold off from cutting rates for as long as possible, that "if only for symbolic reasons" there is some merit in keeping rates high for the moment.
The Bank believes that with interest rates falling, the Government should not add more money into the economy through the Budget. It is worried that any further boost to take-home pay could push inflation even higher, undermine competitiveness and even lead to job losses.
But economic analysts believe the Government will not heed the Bank's warning. Mr Jim O'Leary, chief economist at Davy Stockbrokers, said that if the Minister for Finance, Mr McCreevy, increased indirect taxes on tobacco and alcohol or VAT to offset income-tax reductions, it would only boost the rate of inflation by pushing up prices. Increases in other taxes such as capital gains or property taxes are not "politically palatable", he noted.
The Bank has highlighted a number of warning signals on inflation. Borrowing from financial institutions has been booming, leading to higher retail sales and to soaring house prices. While the Bank concedes that this has had a limited inflationary effect so far, a continuance of this trend is seen as a "significant inflationary risk".
Dr Casey also pointed to a general pay increase across the economy of about 5.5 per cent in 1997, well above the 2.5 per cent norm of Partnership 2000.
Nevertheless, the Bank is sticking with its 2.75 per cent prediction for annual inflation this year, but says it is likely to remain at the same high level next year.
Growth is also expected to remain strong at 7.75 per cent of Gross National Product, although it will drop back to what the Bank sees as a more sustainable level of around 5 per cent in "a few years". Analysis: page 18