As credit turmoil grows, U.S. heads for recession

WASHINGTON Wed Apr 9, 2008 6:22pm EDT

New homes are being constructed in Carlsbad, California January 18, 2008. REUTERS/Mike Blake

New homes are being constructed in Carlsbad, California January 18, 2008.

Credit: Reuters/Mike Blake

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WASHINGTON (Reuters) - The U.S. economy is headed for recession this year and there is a 25 percent chance world growth will drop to 3.0 percent or less, a level that would be considered recessionary, the International Monetary Fund said on Wednesday.

The IMF said the global expansion of the last five years was fast losing ground in the face of a major financial crisis brought on by a downturn in the U.S. housing sector that continues "full blast."

The IMF's latest World Economic Outlook put world growth at 3.7 percent this year, the second time in four months the global watchdog cut its forecast.

In October, it had looked for growth of 4.8 percent, a forecast it had lowered to 4.1 percent in January to try to account for the world's fast-spreading credit woes.

The IMF sees only a bit of a pick-up next year, with growth reaching 3.8 percent, somewhat slower than that following the 2001 U.S. recession.

In the United States, growth in economic output will skid from a subpar 2.2 percent in 2007 to a bare-bones 0.5 percent this year and 0.6 percent in 2009, the Fund said.

But U.S. Treasury's Undersecretary for International Affairs, David McCormick, said the IMF's forecast for the United States was "unduly pessimistic," also acknowledging that a "significant downturn was underway.

"Those numbers, in terms of the outlook for the United States in 2008 and 2009, as well as the outlook for other regions around the world were significantly below consensus," McCormick told a news conference.

IMF chief economist, Simon Johnson, said a large housing inventory overhang suggests the U.S. housing correction would continue for some time. This would combine with a "broader weakening" of the U.S. economy affecting consumers and consumption and related strains in the labor market.

FALLING HOUSE PRICES

Johnson said the IMF expects U.S. house prices to drop in the order of 14 to 20 percent to the end of 2008.

"That is a fairly large decline by historical standards in the United States; it is a very large decline, but is not unprecedented compared to the experience of other advanced economies in past 30, or so, years," he added.

Meanwhile, the IMF said Western Europe would be affected by the downturn in the United States, cutting the growth outlook for the euro zone to 1.4 percent this year, down from a January forecast of 1.6 percent and off sharply from last year's 2.6 percent expansion.

For 2009, it expects euro-zone growth of just 1.2 percent.

The IMF cautioned that financial market strains would persist until there was greater clarity about the extent and distribution of losses on structured securities, and until banks rebuild capital and strengthen their balance sheets.

Johnson said the first line of defense for governments in dealing with the crisis was monetary policy, followed by fiscal measures. The use of public money should only be considered "in sensible ways to prevent problems from getting worse."

ABOVE-TREND GROWTH

In contrast, emerging and developing economies have so far been less affected by the financial market turbulence and their growth is set to remain above trend, led by China and India.

The IMF said, however, there were signs economic activity was starting to moderate in some emerging and developing countries. Here, countries would not always remain insulated, especially if the U.S.-led downturn worsened, it added.

Meanwhile, rising inflation in the developing world from higher food and energy prices, and overheating pressures as economic growth outstripped potential, were the biggest immediate challenges for policy-makers, the IMF said.

In Asia, robust inter-regional trade has helped to insulate the region from the slowdown in the West, although a sharper downturn could pose problems for export-dependent nations.

It said Japan and the emerging economies of Asia have limited direct exposure to U.S. subprime securities but would suffer spillover in the export sector if demand weakened.

The economic expansion in regional growth locomotive China is projected to moderate to 9.3 percent this year from 11.4 percent in 2007, while growth in India is expected to slow to 7.9 percent from 9.2 percent last year.

(Editing by Andrea Ricci)

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