Light at end of tunnel or false dawn?

WASHINGTON (Reuters) - The world economy may be in for a painful reality check this week, should a heavy slate of housing-related data point to more mortgage malaise.

In the aftermath of the Federal Reserve-orchestrated rescue of investment bank Bear Stearns and deep interest rate cuts, some analysts have begun to speculate that the worst may soon be over for battered global financial markets.

They point to encouraging news in the form of stronger-than-expected earnings from Wall Street bellwethers, including Goldman Sachs and Morgan Stanley, some easing of pressures in credit markets, and a well-received initial public offering from credit card giant Visa.

Yet the sense of panic was still palpable last week as stocks tumbled on the faintest rumor that another bank could be poised to announce more write-downs of bad debt.

"Psychology has now overwhelmed economics," Alan Blinder, economics professor at Princeton University and a former Fed vice chairman, wrote in an editorial in the Washington Post.

So far, U.S. economic data has shown deterioration in the manufacturing sector, a sagging job market and a decline in consumer spending -- three worrisome signs that a recession may have begun.

However, not all the news has been gloomy, with exports in particular providing much-needed support. While the rest of the world economy has cooled somewhat, fears of a U.S.-led global recession have yet to materialize. Indeed, the Organization for Economic Cooperation and Development said on Thursday that euro-zone growth would continue.

"The sky's not falling in," Jorgen Elmeskov, the OECD's chief economist, said in a Reuters interview.

CRACKS IN THE FOUNDATION

This week, a close inspection of the U.S. housing sector may reveal that deep cracks in the economic foundation have yet to be repaired. The financial market turmoil now in its eighth month has its roots in failing mortgages, so until the housing sector is stabilized there is little hope for sustainable economic recovery.

Not only has the slumping housing market hurt the U.S. economy, but because American mortgages were repackaged into complex securities sold all over the world it is also the primary cause of global financial stress.

While no one is expecting this week's reports to show a U.S. recovery under way, economists will be looking for evidence that the pace of the decline is slowing.

First up is data on existing-home sales, due on Monday, followed by the S&P/Case-Shiller report on home prices on Tuesday, and single-family home sales on Wednesday.

Should the week's data confirm there is no end in sight to the housing woes, that may put more pressure on the U.S. government to bail out the mortgage market. U.S. Rep. Barney Frank, chairman of the House Financial Services Committee and a Massachusetts Democrat, has proposed offering $300 billion of government insurance for troubled mortgages if lenders agree to erase some of the loan amount. The White House response has been cool.

Housing problems are not confined to the United States. A report on Thursday showed that Ireland's economy slowed in the final months of 2007, in part because of a construction sector slump as the country's decade-long property boom ended. Lay-offs in the sector helped to push jobless claims in February to their highest level since 1999.

House prices in Germany fell 0.7 percent in February, the first month-on-month decline in four months.

In Spain, construction company SEOP declared insolvency last week, becoming the first major builder to succumb to the credit crunch and slowdown in the housing sector.

Britain's property market has also looked wobbly. On Friday, the Nationwide building society will release its UK house price data. Economists polled by Reuters look for a small decline, which would mark the fifth consecutive down month.

(With additional reporting by Brian Love in Paris, Robert Hetz in Madrid, and Paul Hoskins in Dublin; Editing by Dan Grebler)