The European Commission has warned that a collapse in house prices in a few EU member-states, including Ireland, could threaten Europe's economic recovery.

The Commission's Autumn Economic Forecasts, published yesterday, noted that Ireland, the Netherlands, Greece and Spain had seen house prices rise by more than 7 per cent in the first half of 2003.

The report suggests that Irish house prices may have stabilised this year but the Economic and Monetary Affairs Commissioner, Mr Pedro Solbes, warned that mortgage payments could become a problem if interest rates rise sharply or unemployment increases.

His comments echoed those made by Moody's, the international rating agency, in a review of the Irish banking sector published yesterday. However, the agency added that it was not predicting a significant increase in either unemployment or interest rates at the present.

Mr Solbes said that a house price bubble could sharply reduce consumers' spending power, making economic recovery more difficult.

"On the domestic side, one downside risk is represented by the effects on private consumption of a reversal in house prices in member-states where valuations are very high," he said.

The report acknowledges that economic growth in 2003 - which it estimates at 0.8 per cent in the euro zone and 0.4 per cent in the EU as a whole - has been disappointing for the third year in succession.

It predicts that a net figure of 200,000 jobs will be lost in the euro zone in 2003, the first decline in employment since 1994.

Mr Solbes blamed the war in Iraq and the prolonged stock market decline for the EU's disappointing economic performance, but predicted that better times are ahead.

"There are encouraging signs that the worst is behind us. An upturn in business confidence is apparent, while consumer confidence is also showing slow but steady signs of improvement," he said.

The Commission expects the turnaround to materialise in the second half of this year, with economic growth in the euro zone rising to 1.8 per cent in 2004 and reaching 2.3 per cent in 2005.

The report warns, however, that France and Germany will exceed the euro zone's 3 per cent budget deficit limit again in 2004 and 2005, unless they change their economic policies.

This would mean that Europe's two biggest economies would breach the rules of the Stability and Growth Pact for four years in succession.

The Commission predicts that real GDP growth in Ireland will fall to 1.5 per cent in 2003, compared with 6.9 per cent last year. It suggests that an improvement in the world economy will boost Irish exports, enabling economic growth to reach 3.7 per cent in 2004 and 4.9 per cent in 2005.

"On the domestic side, private consumption is supported by a gradual rise in real disposable incomes and a modest fall in the savings rate.

By contrast, the contribution of public consumption to growth falls by virtue of further spending restraint and the announced cap on public-sector employment," the report said.

The Commission expects unemployment in Ireland to rise slightly to 5 per cent in 2004 but to remain stable in 2005.

It notes that inflation has eased to below 4 per cent since May, and praises moderate wage increases in the Sustaining Progress Agreement as a boost to competitiveness.

The report suggests that new user-charges, such as the bin charge, have hampered the fight against inflation and suggests that the introduction of further charges could prevent Irish inflation from moving into line with the euro-zone average.

"The downward pressures stemming from weak activity, moderating earnings growth and a stronger currency have been partly counteracted by a range of increases in indirect taxes and user-charges," it said.

The Minister for Finance, Mr McCreevy, said that the Commission's forecasts were in line with the Government's own data and that he shared the report's confidence that Ireland's medium-term growth prospects remained good.

"Keeping public expenditure on target will be important if our inflation rate is to continue to moderate.

"New management and control mechanisms have been put in place to this end," he said.