The Governor of the Central Bank has warned the Minister for Finance that it would be counter-productive for it to make policy decisions in the budget that would stimulate demand.
In his annual pre-budget letter, Gabriel Makhlouf said if overheating becomes pronounced it could result in a period of higher and more prolonged inflation in Ireland than currently expected.
This could end up "ultimately damaging the competitiveness of the Irish economy and potentially undermining its ability to deliver sustainable growth in living standards," he said.
The comments are contained in the letter sent to the Minister for Finance Michael McGrath yesterday.
Mr Makhlouf said both near and longer-term objectives point to distinct choices and priorities for the overall stance of fiscal policy next year.
He added that they also point to the need for careful management of the public finances in the years ahead.
The Governor said there are signs of binding capacity constraints in the economy and labour market contributing to more robust domestically-driven price inflation and that there are similar dynamics appearing in other advanced economies.
"The outlook for inflation continues to be to high for too long across the euro area," Mr Makhlouf said.
"The longer inflation persists, the greater the damage, and to everyone in society."
"The ECB's policy rate will need to be brought to levels sufficiently restrictive to achieve a timely return of inflation to our two per cent medium-term target and kept at those levels for as long as is necessary."
Last week the Governing Council of the European Central Bank increased its key policy rates by 0.25%.
This brings to 4% the total increase announced so far since rates began rising last July.
"Transmission has been advancing as interest rates on loans to firms and households rise and lending volumes are declining but, as monetary policy affects the economy and inflation with long and varied lags, its full effects are still likely ahead of us," the Governor wrote.
Mr Makhlouf also said that persistently high inflation presents risks to domestic financial stability.
The Central Bank chief also warned that it remains important that excess receipts from corporation tax are not used to fund permanent increases in spending commitments.
He said the concentration of corporation tax receipts leaves the revenue base of what is the State’s second largest tax head highly exposed to the decisions and profitability of a very small number of companies, almost entirely in the pharma and technology sectors.
