G7 outlook takes another punch from credit crunch

By Ross Finley

LONDON (Reuters) - The economic outlook for the world's richest nations has taken another punch from a year-long credit crisis which has pummeled financial markets in recent weeks while inflation accelerates, a Reuters poll showed.

While U.S. growth fared better in the first half of the year than many people had forecast a few months ago, economists are taking a hatchet to next year's numbers and now predict interest rates will hold steady instead of rising imminently from 2.0 percent.

That wait-and-see attitude holds for most rate-setters across the G7, which comprises the United States, Japan, Germany, Britain, France, Italy and Canada.

"Central banks are on an extraordinary tightrope between staving off recession and containing inflation," said Stephen Pope, economist at broker Cantor Fitzgerald in London.

The poll of around 250 economists was taken July 16-23, after U.S. Treasury Secretary Henry Paulson announced steps to shore up struggling mortgage financiers Fannie Mae and Freddie Mac, a plan that has calmed stock markets for the time being.

The poll also followed Federal Reserve Chairman Ben Bernanke's sobering testimony last week. The poll found U.S. rates are set to remain on hold until end-March 2009 but should end next year one percentage point higher, at 3.0 percent.

While growth prospects are falling away sharply for Britain, and dimming in Germany, Italy and Japan, economists are not optimistic either that inflation will soon be tamed in the G7.

Economists raised their 2008 U.S. Gross Domestic Product (GDP) growth forecasts to a median 1.3 percent, annualized, from 1.1 percent predicted last. But they slashed the 2009 consensus by 0.5 percentage point to 1.8 percent.

That was the biggest downgrade to a full-year U.S. GDP figure since the credit crunch began last August and there is now a 60 percent chance of a recession in the next 12 months, up from 50 percent one month ago.

Still, the fact that few analysts have forecast two straight quarters of shrinkage in GDP -- the typical definition of recession -- may be grounds for optimism that the U.S. may escape the clutches of the credit crunch sooner than many expect.

HOUSING MARKETS MATTER

Much will depend on how quickly the U.S. housing market, which has seen average prices fall more than 15 percent from their peak and is in the midst of its worst period since at least the World War Two, will find a bottom.

That will help to steer where inflation goes from here.

"The lingering drags from housing combined with the slow healing in the financial sector ought to provide at least one source of eventual stability in containing the threat of a runaway inflation," said Citi's chief U.S. economist Robert DiClemente in a note to clients.

The outlook for Britain, where housing prices are falling sharply following a boom of the past decade, is crumbling and has many economists making comparisons with two years ago in the United States.