IMF Says U.S. Economic Slowdown Less Than `Feared'

IMF Says U.S. Economic Slowdown Less Than `Feared'

June 20 (Bloomberg) -- The International Monetary Fund said the U.S. economic slump has been shallower than estimated and warned the Federal Reserve may have to raise interest rates ``quickly'' to contain inflation.

IMF economists, after annual consultations with U.S. officials, raised their forecast for growth next year to 2 percent from 1.6 percent. Growth will be ``roughly flat'' in 2008, the Washington-based agency said in a statement today. In April, the IMF predicted a 0.7 percent contraction in the final quarter of 2008 from 2007.

The fund's assessment echoes Fed Chairman Ben S. Bernanke, who said last week the danger of a ``substantial downturn'' had receded. Investors foresee the Fed raising interest rates later this year to curb inflation as rising food and energy costs hurt consumer spending, the source of more than two-thirds of GDP.

``The slowdown in the U.S. has been less than feared, and a recovery should begin next year as important headwinds are overcome,'' the IMF said. ``A more rapid recovery is clearly possible given the substantial policy stimulus and proactive response of financial markets to repair balance sheets.''

The central bank's Federal Open Market Committee next meets June 24-25, when investors expect policy makers will keep the benchmark rate at 2 percent, after seven reductions since September.

The Fed so far has struck the right balance between supporting growth and guarding against inflation, the fund said.

Fed `On Hold'

``Monetary policy settings are now broadly supportive of recovery and a risk-management approach would suggest that policy should be on hold,'' the fund said, nothing that bond markets are indicating that price expectations are edging up. ``Vigilance will be required, given the stimulus in the pipeline and the imperative of keeping inflation expectations well in check.''

U.S. consumer prices rose more than forecast in May on record oil prices, and confidence among Americans slumped to the lowest level since Jimmy Carter occupied in the White House. The consumer price index increased 0.6 percent, the most since November, after a 0.2 percent gain the previous month.

American consumers anticipate an annual inflation rate of 3.4 percent in the coming five years, matching the highest level since 1995, a Reuters/University of Michigan survey showed last week.

The IMF said it expects a ``lessening'' of inflationary pressures, without providing a timeline. ``Thus it could become necessary to withdraw stimulus quickly as the economic recovery gains traction,'' it said.

Tax Rebates

Economic growth also may get a boost from about $117 billion in tax rebates that are providing ``welcome support to activity at a critical time,'' the fund said.

``The U.S. economy has held up well and has avoided the hard landing that generally follows such hard shocks,'' John Lipsky, the IMF's first deputy managing director, said at a press conference. ``The response of policy makers has been relatively quick and decisive and we think these will help cushion the shocks.''

The IMF added that pressures on the budget limit the room for future fiscal expansion. If further action becomes necessary ``it could most effectively be targeted to the housing and financial sectors at the root of the current problems.''

The fund said that any support for the U.S. housing market needed to avoid creating a moral hazard, encouraging people to take risks with the understanding that the government will cover their losses.

Mortgage Modifications

IMF economists said they supported action by Congress to encourage voluntary mortgage writedowns and said a Democratic plan to let bankruptcy judges write down mortgage principal ``warrants consideration.''

``The administration has supported measures encouraging lenders to avoid foreclosures by modifying loans for borrowers in difficulty,'' the fund said. ``Policies need to be mindful of moral hazard but further action to limit avoidable foreclosures is justified by risks that house prices could fall below equilibrium.''

The IMF backed Treasury Secretary Henry Paulson's proposal released in March to overhaul the regulation of U.S. financial services. Paulson's 218-page ``Blueprint for Regulatory Reform'' called the current system for monitoring capital markets outmoded and sought an expanded role for the Fed to monitor financial firms.

``The Treasury blueprint provides a sensible basis for comprehensive reform and simplification of the regulatory system,'' the fund said.

Bear Stearns Rescue

The Fed in March engineered JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. and became lender of last resort to the biggest bond dealers through the Primary Dealer Credit Facility. The PDCF lets securities firms borrow from the Fed at the same discount rate charged to commercial banks.

``The extension of the public safety net to primary dealers, notably the major investment banks after the collapse of Bear Stearns has underlined the importance of effective systemic regulation,'' the IMF said. ``The Fed's widening of access to its discount window following the collapse of Bear Stearns has lowered systematic risks but not eliminated them.''

The fund called for stronger regulation and supervision of investment bank holding companies by a single supervisor, ``possibly the Fed.'' The lender also urged for ``closer supervision of liquidity conditions in bank holding companies.''

The fall in the dollar had not yet eliminated trade imbalances, the fund said.

Exchange Rates

``Bilateral rate movements have not corresponded to the existing pattern of imbalances, with larger changes against freely floating currencies (such as the euro) than against currencies with large current account surpluses (such as the renminbi),'' the report said. ``Thus, the reduction in tensions in the international exchange rate and trade system has been more limited than suggested by the dollar's real effective exchange rate.''

The IMF's statement today will be followed in coming weeks by a full ``Article IV'' statement, providing a more detailed analysis of the U.S. economy.

BLOOMBERG