Economy weak but not enough for recession: report

SAN FRANCISCO (Reuters) - The U.S. economy will shrink in the second quarter, but avoid a recession this year as housing's drag will ease in the second half, helping normal growth return next year, according to a UCLA Anderson Forecast report released on Tuesday.

"The data don't yet add up to a recession and there is nothing here to challenge the basic story of sluggishness that we have had for two years," the forecasting unit's report said, adding: "Our no-recession forecast remains nervously intact."

Amid a cooling economy, the labor market is only slowing so it lacks enough drag to force a recession, according to the forecasting unit.

"The weakening job market is completely consistent with our longstanding forecast of a housing adjustment that is mostly confined to housing," the report said.

The UCLA unit added that its forecast also hinges on whether falling home prices depress consumer spending, and that it does not expect consumers to overreact.

"It has been our view that the reaction to the reality of lower home prices will be slow and smooth, which is a reason to forecast slower growth in the future, not a recession," the report said.

"In the last year or two, personal consumption expenditure has been weakening a bit, but it seems pretty clear that the news on the housing front hasn't forced a rapid consumer adjustment so far," the report said.

The forecasting unit noted the economy has withstood the housing slump -- especially eight consecutive quarters of declines in housing starts -- because the homes market and jobs market have become disconnected.

"Delinquencies and foreclosures went hand-in-hand with job losses" in the past, the unit's report said. "This time has been entirely different. People are walking away from their homes because home prices have declined, even though their jobs and incomes are secure."

Many who bought homes in recent years see defaulting on a mortgage as cutting losses on an investment, said Edward Leamer, director of the forecasting unit.

"The new ethic is that buying a home is a trial, and you see if it works for you financially ... It's an investor's ethic," Leamer said. "The old ethic was you would continue to service your debt barring a catastrophe like losing your job."

The UCLA Anderson Forecast unit expects anemic real gross domestic product growth of 0.4 percent this quarter, followed by a 0.4 percent contraction next quarter.

The economy will rebound in the third quarter with 3.0 percent growth, followed by 2.5 percent growth in the fourth quarter and full-year growth of 1.5 percent, the unit said.

It projects the unemployment rate will rise to 5.5 percent in the fourth quarter from 5.0 percent this quarter, and average 5.3 percent this year and 5.6 percent next year amid sluggish payroll expansion as the housing downturn bottoms.

"There's little hiring and little firing," Leamer said. "We're going to have the completion of a housing catastrophe without having the job losses that usually go hand in hand with that."