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DUBLIN (Reuters) - Ireland's economy will crawl to a virtual halt this year, defying government hopes of modest growth, the central bank said on Monday, underlining the challenge the country's leaders face to revive its fortunes.
Cowen, the most unpopular Irish prime minister in modern history, will unveil a four-year plan next month for tackling the worst budget deficit in the EU and prospects of a recovering domestic economy helping to narrow the gap appear remote.
The central bank cut its growth forecast for Gross Domestic Product (GDP) this year to just 0.2 percent from 0.8 percent previously and said that, given international fears about Ireland's finances, the government could not shy away from steeper cuts despite the bleaker outlook.
But analysts warned a continued diet of bad news on the economy for Ireland's recession-weary consumers could tip the country into another slump.
"Against the background of sharply increased concerns about fiscal sustainability, the main priority in the short term is to ensure that the 2011 budget credibly demonstrates the first step of a reprogrammed tighter fiscal plan," the central bank said in its latest quarterly bulletin.
Cowen shocked taxpayers last week when he revealed they may end up with a clean-up bill of up to 50 billion euros (43.3 billion pounds) following years of reckless bank lending during the boom years of the "Celtic Tiger" economy.
The bank bill will quadruple Ireland's debt levels from 25 percent of GDP before the crisis to an estimated 99 percent and means Cowen will have to make fiscal adjustments next year above an initial target of 3 billion euros.
The premium investors demand to hold Irish debt rather than German Bunds, which blew out to a record 475 basis points last week, has narrowed since and eased further to 415 bps on Monday on the prospect of Irish pension funds buying bonds.
The central bank is hoping that consumer demand will slowly start to pick up next year but analysts said a daily gush of bad news could send the economy back into recession.
"The concern I have now is that the dreadful news every day of the week and the front page of every newspaper is depressing people and affecting consumer sentiment to the point that you could have some kind of double-dip scenario in Ireland," said Eoin Fahy, chief economist at KBC Asset Management.
The government still has a GDP growth forecast of 1 percent for this year but is set to publish new forecasts this month.
On a Gross National Product basis, viewed as a better gauge of the domestic economy because it strips out profits of multinationals operating in Ireland and interest payments on foreign debt, the economy will shrink by 1.7 percent this year, the third straight year of decline, the central bank said.
The GNP forecast highlights how Ireland's growth prospects are almost entirely driven by exports and at the mercy of global demand.
Reflecting the threat of further slowing international growth, the central bank warned that a downgraded GDP growth forecast for next year of 2.4 percent was at risk of being trimmed further.
It had forecast 2011 GDP growth of 2.8 pct in its previous quarterly bulletin and 2.2 percent for GNP.
In an interview with Reuters, the chief executive of Danske Bank (DANSKE.CO) said it would be 2012 before recovery takes hold in Ireland particularly given the austerity measures ahead.
Ireland's deficit is expected to blow out to an eye-watering 32 percent of GDP this year because EU accounting rules mean it has to add all of the banking bill to its shortfall figure.
The figure is a one-off and Cowen has said the costs of the bank cleanup will be spread out over at least a decade.
But even on an underlying basis, the central bank said it expected Ireland's deficit to be around 11.6 percent this year, nearly four times the EU limit.
Cowen has promised to get the deficit to under 3 percent of GDP by 2014.
Exchequer data for September will be released at 3:30 p.m. BST on Monday.
In the first eight months of the year, Ireland's underlying deficit figures have come in line with targets but Brussels wants Dublin to outline in greater detail next month how it will get its finances in line by 2014.
Reporting by Carmel Crimmins; Editing by Ron Askew, John Stonestreet