Dublin - Ireland will need to rethink its plan for cutting a bloated budget deficit due to weak economic growth and higher borrowing costs, though the price of its bank bailout will not be as high as some fear, the central bank said on Monday.
Touted last year as a role model for cutting spending aggressively after a property market crash, the rising cost of rescuing its banks has made investors nervous about a full-blown debt crisis, sending Irish borrowing costs soaring to levels that are unsustainable over the long-term.
The head of the central bank signalled on Monday the government needed to take even tougher fiscal action in the next few years to win back investor confidence and get borrowing costs down.
"I think these kinds of budgetary programmes do need to be reprogrammed in the light of circumstances," Patrick Honohan told an audience at a regulatory conference in Dublin.
"My overarching goal is to ensure that the government's funding costs are not damaged by a market perception that the government might not be going to deliver what it is going to deliver."
Despite three austerity budgets in two years, the cost of propping up nationalised Anglo Irish Bank [ANGIB.UL] could push Dublin's 2010 budget deficit to around 25% of gross domestic product (GDP), far above an EU limit of 3%.
Ireland has vowed to return its finances to the EU target by 2014 and Honohan said that the shortfall could come close to that if the economy stays on an originally envisaged course, but he added the real economy and the cost of government borrowing had so far evolved in a "less favourable way".
Ireland's 10-year bond yield was around 6.5% on Monday, driving the yield premium investors demand over German bunds to a fresh euro lifetime high of 414 bps. That is still less than half that of Greece.
The finance ministry said this year's budget trends were in line with plans so far and it was committed to further stabilisation measures going forward.
"The government is in agreement with the governor that it is important for Ireland that we tackle our public finances," it said in a statement.
The next update on fiscal plans is expected in the second half of October after the release of some important economic data, it added.
Bank bailout fears overdone
Last week the government and the International Monetary Fund sought to calm financial markets after a newspaper report on the possibility of an IMF bailout sent investors running for cover.
"Recent movements in the yield spread on government debt -- both for Ireland and for some other countries -- readily demonstrate the costs that can result unless international lenders remain convinced that the budget is going to be kept on a convergent path," Honohan said.
A further test of sentiment will come when Dublin auctions up to €1.5bn of bonds on Tuesday.
Despite his budget warnings, Honohan also said some of the estimates for the scale of the bank bailout cost were overdone.
Rating agency Standard & Poor's recently said the cost of bailing out Anglo could reach €35bn ($46bn), versus the nearly €23bn Ireland has so far into the nationalised lender.
"It will be less than numbers recently touted around," Honohan said. He did not name S&P.
The budget and banks issues have put Ireland back at the forefront of concerns for investors worried that another euro zone state may wind up in similar trouble to debt-laden Greece.
In Athens, a source at the central bank told Reuters on Monday that Greece will postpone stress testing its banks until later in the year to allow its largest lender to complete a big rights issue.
Honohan told the conference that Ireland's banks had made good progress in meeting tough new capital requirements.
The European Union's Economic and Monetary Affairs Commissioner Olli Rehn also said on Monday he was confident that Ireland would deal with the current problems.
"I have full confidence on Ireland and its capacity to act with determination to complete the financial repair and the necessary restructuring of the banking and financial sector," Rehn said at an event in Estonia.