Economic outlook "subprime," no recession: report

SAN FRANCISCO Wed Jun 18, 2008 8:19am EDT

A vacant house for sale is pictured at the Green Valley Ranch neighborhood in Denver, July 26, 2007. The economy will likely avoid a formal recession, but its outlook through the end of next year is decidedly ''subprime'' with the deep housing downturn restraining growth to just above 1 percent, a UCLA Anderson Forecast report released on Wednesday said. REUTERS/Rick Wilking

A vacant house for sale is pictured at the Green Valley Ranch neighborhood in Denver, July 26, 2007. The economy will likely avoid a formal recession, but its outlook through the end of next year is decidedly ''subprime'' with the deep housing downturn restraining growth to just above 1 percent, a UCLA Anderson Forecast report released on Wednesday said.

Credit: Reuters/Rick Wilking

SAN FRANCISCO (Reuters) - The economy will likely avoid a formal recession, but its outlook through the end of next year is decidedly "subprime" with the deep housing downturn restraining growth to just above 1 percent, a UCLA Anderson Forecast report released on Wednesday said.

A "witch's brew of the popping of the housing bubble, a wounded financial system and increasing inflationary pressures coming from rising commodity prices will keep the economy on a subprime growth path for the next several quarters," according to the forecasting unit's report.

Despite aggressive Federal Reserve interest rate cuts since last September intended to stimulate the U.S. economy, it will post "tepid" average gross domestic product growth rate of 1.2 percent from the third quarter of 2007 through the fourth quarter of 2009, the report said. It also sees the unemployment rate hitting 6 percent by the end of next year, up from 5.5 percent in May.

"Moreover, because both headline and core inflation will remain uncomfortably high over the next several quarters, we believe the Federal Reserve has ceased cutting interest rates and that the next change in policy will be to increase the federal funds rate starting in mid-2009," the report said.

The unit's economists expect the remainder of this year and 2009 to resemble recoveries from recessions in 1990-91 and 2000-01, each spurred largely by asset price declines, in commercial real estate in the former and stock prices after the Internet bubble burst in the latter.

CONSUMERS TAPPED OUT

The housing market's steep decline -- its worst tumble since the Great Depression, so far wiping out about $3 trillion in home equity -- coupled with gasoline prices topping $4 a gallon argues against a resurgence of brisk consumer spending in the near term.

"To be sure the $108 billion in tax rebates will certainly help in the third quarter, but in our view it will be analogous to a one quarter 'sugar rush' for the economy," the report said.

"In fact the combined effect of the waning effects of the tax rebates and the end of the investment incentives associated with the government's stimulus package in December, could very well lead to a decline in GDP in the first quarter of 2009," the report added.

On a broader note the report said growth in consumer spending, financed by the collapse in savings and increased borrowing from abroad, may have peaked.

"The weaker exchange value of the dollar is signaling that the game may be up making it more difficult for the U.S economy to continue to consume more than it produces."

Meanwhile, net exports are on the upswing, adding less than 1 percent to real GDP growth, but just enough to stave off recession, the report said.

The Federal Reserve appears to turning its attention toward traditional inflation concerns amid higher commodity prices. "What is worrying the Fed is that real interest rates are lower now than they were during the deflation scare of 2003-04," the report said.

"Most observers now believe that it was the very low real interest rates of that period that set the stage for the housing and credit bubbles that came later," it added. "As a result, we do not believe that the tepid economic growth we are forecasting will prevent the Fed from raising interest rates in mid-2009."

UCLA Anderson forecasters also expect tighter regulation of the financial services in place next year after the Federal Reserve's sponsored rescue of Bear Stearns BSC.N and its opening of its discount window to Wall Street investment banks.

Those moves "permanently changed the role of the Federal Reserve in the economy," the report said. "We suspect that just as after the Panic of 1907 led Congress to create a national monetary commission that in turn recommended the creation of the Federal Reserve System in 1913, a similar commission will come into being next year."

"By the time the process is completed, it is highly likely that large investment banks, hedge funds, mutual funds and pension funds will come under the umbrella of a new regulatory regime."

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