A severe energy shock scenario caused by the Iran war could push inflation above 4% this year, according to the Central Bank.
It has also warned that household incomes would also be eroded by higher fuel prices.
In its latest economic forecast, it said that domestic growth would be 2.9% this year, down from 4.9% in 2025.
The bank said its baseline assumption was that inflation would be 2.9% on average during 2026. But it is said in a severe scenario, inflation would be 4.2% in 2026 and 4% the following year.
Central Bank Director of Economics and Statistics Robert Kelly said: "The extent of these effects really is dependent on the duration and intensity of the conflict and the scale of damage to critical infrastructure in the Middle East.
"These events highlight just how sensitive the Irish economy is to global developments and the need to maintain and build resilience in our domestic economy and public finances."
The bank said that the underlying deficit, when windfall gains paid by multinationals are excluded from the public finances, was set to double by 2028 as spending outpaces revenue collected by the State.
It also warned that the Government's ability to respond to the effects of the Iran war could become "more constrained".
The bank said the Coalition should focus on "targeted, temporary and tailored measures" to support the most vulnerable households.
In its forecast, it said there would be a "gradual increase" in unemployment to just above 5% as the economy grows at a slower pace.
One housing, the bank predicted home completions will reach 40,000 this year up from 36,000 in 2025.
It expected that building will reach 43,000 units in 2027 and 46,000 in 2028.
It said higher housing output depended on the delivery of necessary public infrastructure.
Speaking on RTÉ's Morning Ireland, Mr Kelly said the Government's response to the energy crisis may become more constrained in future, as it has "less headroom to respond" when compared to a similar situation in 2022.
"When we say this, we're talking about relative to 2022, when we would have had higher levels of excess corporation tax within the system," he said.
"We conditioned that on the medium-term fiscal plan we saw released just before Christmas.
"When you look at that, you actually see what we call the underlying deficit, that's when you create the Government's balance without excess corporation tax. That's actually set to double in their plans there.
"So actually, there's less headroom to respond, but the way in which they have responded will be within that," Mr Kelly said.
He added that how the measures to help customers were designed were "crucial".
"They have a billion euro, basically, of a contingency fund announced in a large budget," he said.
"The package here is about 250 to 320 million [euro], so it is within that.
"Then crucially, it's how these cost-of-living measures themselves are designed. That is crucial as to what their impacts would be."
