The Central Bank has forecast a continuation of the gradual recovery in economic activity that is currently under way, though at a slightly slower pace than previous forecasts.

In its first quarterly bulletin of the year, the Central Bank said a slowdown in Ireland's main export markets will impact on growth.

In its bulletin, the Central Bank has pencilled in GDP growth of 1.3% this year. This compares with 1.7% in its previous forecast, and reflects a less favourable international outlook.

For the domestic economy, the bank has projected GNP growth of 0.5%, and growth in employment of 0.3%.

While the employment growth is small, it is the first projected growth since 2007. The Central Bank added that all of it will come from the private sector.

But the bank raised its forecast for economic growth for 2012 after better than expected retail sales data.

It said it expects GDP to grow by 0.7% in 2012 - the second year of growth since 2007. This is an increase from its earlier estimate from 0.5%.

The Central Statistics Office is due to release 2012 GDP figures in March.

The bank warned that due to Ireland's high dependence on exports, further progress is needed to reduce costs in the economy to improve competitiveness and increase flexibility, especially in the public sector.

It also said the Government should not be tempted to ease back on its budget adjustment plans because last year's deficit was smaller than anticipated. It said it should use the ground gained to reach a 3% deficit faster than planned.

The bank said this will reduce uncertainty, contribute to domestic growth and reduce Government borrowing costs.

The Central Bank said investment by business is expected to pick up again this year, building on a return to investment growth seen last year, which happened sooner than expected.

It also foresees a modest return to construction growth next year.

Based on recent figures from the Central Statistics Office, it said there is "tentative reason to expect that the low point in investment may have been reached".

The Central Bank said it expects a further decline in consumer spending this year, but at a much more moderate pace. It has projected a fall in consumer spending of 0.4% this year, and slight growth of 0.2% next year as international conditions improve.

Meanwhile, the Central Bank's chief economist said today that the banks must do more to deal with mortgage arrears, but they are well enough capitalised to deal with potential losses from the sector.

"Much more will be needed to address mortgage arrears," Lars Frisell said at a briefing in Dublin. But he said the banks should have enough capital to deal with the arrears "even if it implies capital losses".

Irish mortgage arrears have risen to record levels, with one in six home loans not being fully repaid.