UPDATE 1-IMF cuts U.S. 2014 growth forecast to 1.7 percent

Wed Jul 23, 2014 1:20pm EDT

(Adds details on Fed rate hikes, risks, fiscal spending)

By Anna Yukhananov

WASHINGTON, July 23 (Reuters) - The International Monetary Fund on Wednesday said it expects the U.S. economy to grow 1.7 percent in 2014, even more slowly than it predicted a month ago, as weakness in the first quarter offsets an expected pick-up in the second half of the year.

The IMF, which in June forecast 2 percent growth for the world's largest economy this year, said U.S. activity should accelerate to a pace of 3 percent to 3.5 percent in the rest of 2014, and grow by 3 percent next year and in 2016.

"Still, the drag on growth from the first quarter contraction will not be offset," IMF staff said in their yearly analysis of the U.S. economy.

U.S. GDP contracted at a 2.9 percent annual pace in the first three months of the year, dragged down by a weak housing market, a slower pace of restocking by businesses and lower exports. It was the sharpest decline in five years.

Lower growth expectations should contribute to continued slack in the labor market for the next three to four years, with the United States remaining below full employment until 2018, the IMF said.

It added that the U.S. Federal Reserve could keep its benchmark interest rates at zero beyond the middle of 2015, the date implied by policymaker forecasts, as long as inflation and financial stability concerns remain subdued.

The IMF said it believed the U.S. central bank could then raise rates at every other policy meeting, in what would be a more gradual approach than median Fed forecasts currently suggest.

Future U.S. growth could be disappointing if U.S. interest rates rise too quickly, there is a broader and concerted slowdown in emerging markets, and increasing geopolitical tensions in Iraq and Ukraine prompt higher energy prices and severe financial and trade disruptions, according to the IMF.

The IMF also warned that an aging U.S. population meant the economy would not be able to grow above 2 percent in the longer-term without significant reforms, including tax and immigration changes, more investment in infrastructure and job training, and the provision of childcare assistance, which could help lure more Americans into the workforce.

Even without these measures, the IMF said there is "a strong case" for more government spending to support the economic recovery in the near-term, as long as there is a plan to deal with high entitlement spending later on.

For the first time in several years, the IMF also focused on the deep pockets of U.S. poverty. It urged the United States to expand the earned income tax credit to the poorest workers and boost the minimum wage, which together should help the poor without a making a huge dent in the government's budget.

"We do think (poverty) is macro-relevant, we do think it's important for growth, and both economic and social sustainability in the United States," Nigel Chalk, deputy director of the IMF's Western Hemisphere Department, told reporters. (Reporting by Anna Yukhananov; Editing by Paul Simao)