UPDATE 1-KBW sees consumer-led recession through fall of 2008

(Recasts, adds analyst comments)

By Supantha Mukherjee

BANGALORE, May 21 (Reuters) - Keefe, Bruyette & Woods on Wednesday forecast a consumer-led recession that will extend through the fall of 2008, with the economy emerging from recession into slow growth in 2009, noting that would happen by next Spring.

But Federick Cannon, chief equity strategist at the brokerage, also expects more recapitalizations in the financial sector and U.S. consumers to repair personal balance sheets, retrenching on spending for the remainder of the year.

Cannon believes rising unemployment, higher food and energy costs and declining house prices will have an impact, but expects that by late 2009 consumers will have stronger balance sheets with banks possibly getting more active in promoting lending growth.

But for that to become a reality, he believes the sector will need to refurbish their own balance sheets.

"What has to happen is that we need to recap a significant part of the sector and the global investors with the money to provide for those recaps are going to demand a lot of ownership for it," Cannon said.

He said a lot more recaps in the sector are to come and may well be done at prices below where stocks are currently trading.

"As far as the best opportunity for investors, ultimately it would be financials, as they have gone down the most and they offer the best upside. But we think there is more downside to come first," Cannon noted.

On the health of the U.S. economy, Cannon said the consumer or any indicators on consumer and discretionary spending, would be seen as key for any turnaround.

"Watch the consumer and that will tell you what is happening to the economy. Right now consumer sentiment and confidence is falling very rapidly. We think consumer sales will follow that. So, I would think that when we see a bottom of consumer confidence and senitiment that will be the key indicator."

He said the brokerage's economic baseline calls for a moderate recession in 2008, adding that the small rise in Gross Domestic Product in the first quarter of 2008 has only reinforced its moderate recession forecast.

Cannon said the outlook remains somewhat more cautious than the consensus of economists, although less so than when the brokerage first called for a recession in December.

"The reason for our cautious outlook is the combination of weakening leading economic indicators and the increasing tightening of consumer credit by the banks and financial institutions under coverage," Cannon said in a research note.

On May 16, the Reuters/University of Michigan Survey of Consumers showed that U.S. consumer confidence tumbled to its lowest level in 28 years in the month.

Cannon's remarks come a few days after prominent U.S. banking analyst, Meredith Whitney, offered a gloomy outlook for top U.S. banks.

Whitney warned that consumers' growing struggles to pay their debts will increase losses for lenders. (Reporting by Supantha Mukherjee in Bangalore; Editing by Bernard Orr)