OECD cuts U.S. forecast, recession not ruled out

By Brian Love, European Economics Correspondent
DUBLIN (Reuters) - The OECD on Wednesday reduced its forecast for U.S. economic growth and recommended a rapid cut in interest rates to limit the fallout from a housing and mortgage market slump that has sparked global financial market turmoil.
In an update to its economic forecasts for major industrial nations, the Paris-based Organisation for Economic Cooperation and Development also said interest rates should not be raised for the moment in Japan or the 13-country euro currency zone.

It said it was impossible at present to evaluate the potential damage which broader financial market turmoil could add to the direct impact of a sharp downturn in U.S. housing and a defaults crisis in the subprime mortgage market there.

"Downside risks have become more ominous," the OECD's chief economist, Jean-Philippe Cotis, said in a statement.

The OECD was not for now predicting U.S. recession but was not discounting the possibility either, he added in an interview with Reuters.

He recommended that the U.S. Federal Reserve reduce its key interest rate by a quarter of a percentage point this month to shore up growth, but without going so far as to give foolhardy investors the idea that public authorities would always be there to bail them out by cutting the cost of credit.

He presented updated GDP forecasts for several countries and said U.S. growth was expected to be 1.9 percent this year rather than 2.1 percent forecast previously, and that growth in third and fourth quarters would be much weaker than a surprisingly strong showing reported for the April-June period.

"Recent developments have revealed serious imperfections in the functioning of U.S. housing markets and, more broadly, in credit markets worldwide," Cotis said.

The U.S. housing market downturn is widely regarded to have set in two years ago but the troubles caused by rising interest rates on already high-cost loans to poor, or subprime, borrowers surfaced later, recently triggering fears of a wider U.S. slump and global credit crunch.

"Our diagnosis is a slowdown," Cotis told Reuters, conceding that the downturn was bigger than the OECD had expected. "We cannot rule out a recession," he added.

The OECD forecast third-quarter growth of 0.5 percent in GDP quarter-on-quarter, which is roughly 2 percent annualized, and a subsequent 0.4 percent for the fourth quarter, which equates to about 1.6 percent in standard U.S. data publications.

Those predictions were on the high side, with large margins of error and an as yet unquantifiable hit from market turmoil that could potentially push either quarter to zero growth or even a contraction, Cotis said.

NOT SO BAD ELSEWHERE, SO FAR

In Europe, growth remained relatively dynamic, and the case for further rises in ECB rates for the euro zone was valid, but not until it became clearer how the gyrations in fragile and fear-riven financial markets would pan out over time, he said.

"For now, 'stay put'," he said of ECB rate policy ahead of a Thursday meeting of the euro zone's central bank, which has been steadily raising rates since December 2005 as the economy of the region began to pull out of the doldrums.

His advice was broadly similar for the Bank of Japan, which has for years had to worry about deflation rather than the risk of inflation that the primary concern of central banks in much of the rest of the world.

The OECD's forecasts for growth in 2007 as a whole were held at 2.4 percent for Japan and trimmed minimally for the euro area, to 2.6 percent from 2.7.

The OECD and Cotis offered no advice on rates to the Bank of England but raised its growth forecast for Britain markedly, to 3.1 percent from 2.7 while it cut Italy's forecast growth to 1.8 percent from 2.0 and raised Canada's to 2.7 percent from 2.5.

Cotis said he still believed other regions such as Europe and Japan could avoid being pulled down as hard as the United States even if the world's largest economy flirted with recession.

"There'd be an impact but would not drag Europe onto the same path as U.S. ... Asia has a momentum of its own, there are consumers there too," he said.

He stressed that the problem at the moment was one caused in the first place by trouble in the subprime segment of the U.S. home loans sector.

While the trouble also concerned exposure to such debt via debt derivatives markets, this was not as big and broad a bubble as the one that preceded the dot-com crash six years ago.

"This is not 2001, when the stock market bubble was a much wider phenomenon. It's not the same thing. We're not talking about a share problem of the same intensity," he said.