Mortgage interest relief should be reduced to cut demand in the housing market, according to the latest economic review from the Organisation for Economic Co-Operation and Development (OECD).
It predicts a gradual pick-up in economic activity next year led by a recovery in exports and says that GDP growth could be running at 5 per cent by 2005.
The main domestic economic risk, it believes, is that a hike in longer term interest rates "could lead to a sudden downturn in the housing market and undermine household confidence".
To help cool the mortgage market, it has advised the Minister for Finance, Mr McCreevy, to cut tax incentives which boost demand for housing "in an already overheated residential market".
The main such incentive is mortgage interest relief - which costs the Exchequer over €200 million per annum - with other special property incentives already due to be abolished at the end of next year.
The cost of borrowing is likely to remain low, the OECD says, and the housing market will remain buoyant, "with the risk of a major correction of house prices in the event of a hike in long-term interest rates".
The report added that "some market segments, such as the buy-to-let market, have become particularly vulnerable, although there is so far little concern over the ability of banks to absorb the effects of a house-price shock on their loan portfolios".
The OECD has previously called for abolition of mortgage tax relief and the imposition of a property tax as a way to cool the housing market. The Department of Finance would not comment on the issue ahead of next week's Budget, but any change to the relief would come as a surprise.
The Paris-based OECD, in its twice-yearly outlook for the industrialised countries, forecast that Irish GDP growth would rise from 1.75 per cent this year to 3.5 per cent in 2004 and nearly 5 per cent in 2005.
The main engines of recovery would be exports and business investment, it forecast, though household spending should also be buoyed by low interest rates, disinflation and improved confidence.
In a generally upbeat assessment, it says that while competitiveness has deteriorated, Ireland still has a strong position in fast-growing areas of the high-tech sector, which may enable potential GDP growth to stabilise at about 5 per cent per annum over the medium term.
The strength of the recovery here will be influenced by the growth in world trade, the report says, while a further rise in the euro or wage pressures could hit competitiveness.
The report is positive on international economic prospects. Years of stagnation are over for the global economy and a strong economic recovery is well under way.
It predicts growth of 4.2 per cent in the US economy in 2004 after 2.9 per cent this year - compared with a paltry 0.3 per cent in 2001, for example.
Japan is poised to pull out of the doldrums with growth of 2.7 per cent this year and 1.8 per cent in 2004, but the 12-nation euro zone will get off the ground more slowly with growth of 0.5 per cent this year and 1.8 per cent in 2004. It believes the main central banks will keep interest rates low until the rebound is established
