The European Commission has acknowledged that changed economic circumstances have ensured the fears that led to a rebuke over last December's budget have not been fulfilled. But the Commission warns that next year's Budget could result in a rapidly shrinking surplus unless the Government exercises caution.

In a report to be presented to EU finance ministers next month, the Commission cites the foot-and-mouth crisis and the world economic slowdown as external factors that have helped reduce overheating.

But it adds that the Government took heed of the EU reprimand - or Recommendation - in implementing the Budget and praises the tax-preferred saving scheme and the tax recovery scheme. Sources close to the Minister for Finance, Mr McCreevy, said last night that he was "not unhappy" at the Commission's report.

The report states: "The implementation of the Budget for 2001 reflected some of the concerns underlying the Recommendation.

"Above all, however, the unexpected economic developments mean the inconsistency addressed in the Recommendation between the Irish budgetary plans and the goal of economic stability has lost part of its force for this year."

The Economic Affairs Commissioner, Mr Pedro Solbes, said the Commission accepted its analysis of Ireland's economy had been overtaken by events.

"Our analysis at the beginning of the year was that the Irish economy was in an overheating situation. But now this situation has been partially corrected," he said. Mr Solbes said he felt neither happy nor unhappy about yesterday's report, and insisted the Commission was only fulfilling its obligations by proposing the reprimand.

"The position of the Commission is that we try to analyse the situation in the different member-states and if something is in contradiction of the Broad Economic Policy Guidelines we have to see if this can be diminished," he said.

But the Health Commissioner, Mr David Byrne, said the report represented the end of Ireland's budget row with Brussels and hinted the Commission would be slow to issue such a rebuke again. "I regard this as a closed chapter. This is the first time this has happened. Lessons have been learned all round," he said.

The EU's reprimand over the budget, issued by the 15 EU finance ministers at the Commission's suggestion, criticised last December's budget as being inconsistent with the EU's Broad Economic Policy Guidelines.

The guidelines had suggested the budget should take action to reduce inflationary pressures but the EU concluded its combination of tax cuts and spending increases would instead feed inflation.

Although the report acknowledges that inflation is easing, it suggests the threat it poses has not disappeared.

"Underlying inflation has remained so far at peak levels, both in terms of recent domestic performance and relative to other euro area countries. While the slowdown can be expected to reduce inflationary pressures, these are not likely to subside completely," it states.