A fall-off in house building will lead to a moderate downturn in the Irish economy this year and in 2008, according to the Economic and Social Research Institute.

The country's main think tank says the decline in growth levels will not be catastrophic, but instead lead to more sustainable growth rates in future.

It says the end of the housing boom will lead to an exchequer deficit of €1bn in 2008, compared to last year's surplus of €3.3bn.

The ESRI's latest quarterly assessment of the economy, published this morning, warns against allowing high inflation to fuel more wage demands.

A return to a more sustainable level of growth is the verdict given to the Irish economy in the report.

It says 2006 marked the peak with economic growth running at 7.4%. That is expected to ease to under 5% this year and 3.7% in 2008, driven by a slow down in consumer spending.

The key challenge now will be to stimulate other sectors of the economy to replace the income and the jobs afforded, up to now, by labour intensive house building.

In that sense the economy is in transition, and the ESRI is looking to the services sector and industry to generate wealth.

But it says workers here are vulnerable in terms of how competitive they are compared to other countries, while the big threat is curbing new wage demands in the face of inflation running at 5%.

In addition to its main report, the ESRI has published a report on housing from UCD economics professor Morgan Kelly.

His research looks at 40 house price booms and crashes that have occurred around the world since 1970. It finds an almost universal truth, the higher the initial boom the larger the bust.