House-price inflation will slow as economic growth eases over the next two years, but the Republic's biggest bank believes the market will not crash.

AIB Global Treasury's latest economic outlook predicts that the amount of wealth generated in the Republic will grow by 6 per cent this year, but slow to around 4.5 per cent by 2008.

At the same time, AIB says that the rate at which house prices are increasing will slow to between 3 per cent and 6 per cent by the end of 2007, and 3 per cent to 5 per cent the following year.

Property prices are this year expected to increase by 12 per cent, and some commentators believe that the market is set for a severe downturn or even a crash.

This is based on the fact that Irish people's debt stands at 150 per cent of their incomes. However, AIB says that the risk of a severe correction is low, and a soft landing for house prices is much more likely.

"We do not envisage a hard landing or crash in either property prices or in construction output," AIB Global Treasury chief economist John Beggs says in the report.

He forecasts that 93,000 houses will be built this year, but adds that housing completions will slow after 2006. Price inflation and interest rate increases are making houses less affordable, Mr Beggs says. The cost of borrowing is a key factor in this.

"We have had five increases of a quarter percentage point since December last, bringing the refinancing rate to 3.25 per cent.

"Though not at an historically high rate, potential buyers may not be too comforted by forecasts that the European Central Bank will stop at 3.75 per cent."

Houses now cost around 11 times people's disposable income, Mr Beggs estimates.

"Looking ahead, more moderate growth in house prices of 3 per cent to 5 per cent is possible over the next few years.

"We see prices in the second-hand market stalling over the winter period before recovering in the spring.

"Inflation in this sector could rise by 0-5 per cent year-on-year by end 2007, down from 11 per cent in 2006. As regards new house prices, this sector is somewhat stronger, but moderation to 5-7 per cent could occur from 13 per cent in 2006."

However, there are pressures in some sectors of the housing market that will keep driving prices, according to Mr Beggs.

Launching the report yesterday, he said there were shortages of family homes in cities like Dublin, Cork and Galway.

He also pointed out that continued employment growth would ensure that demand for housing continued to be strong.

Mr Beggs also says fears that economic growth depends too heavily on the building boom are not justified.

He says the bank expects demand for goods and services within the Republic and exports both to grow by 6 per cent this year. "Consumer spending, Government consumption and fixed investment are forecast to rise by 6.5 per cent, 4.5 per cent and 5 per cent respectively. This can hardly be called lopsided growth."

Mr Beggs suggests that given the strong growth in employment in recent years, growth could well have been underestimated.