Housing slump threatens US economy

The US economy is poised to slow gently but a housing crash is a potential threat and the Federal Reserve will have to stay vigilant on inflation, the IMF said today.

In its twice-yearly World Economic Outlook report, the International Monetary Fund forecast that US growth would reach 3.4% this year before easing to 2.9% in 2007.

The IMF reiterated appeals for President George W Bush's administration to show more ambition in putting the public finances in order and warned that mammoth US budget and trade deficits risk destabilising the world economy.

It also noted that even as US growth slows, inflation has built  to levels that should worry the Federal Reserve after the US central bank last month called a halt to a long-running series of interest rate hikes.

'It is clear that even as the economy slows, inflationary  pressures are rising,' said IMF chief economist Raghuram Rajan. 'If these become entrenched in expectations, the Fed will have to raise interest rates even higher and for longer,' he said.

'So the Fed may soon be on the horns of a dilemma and monetary policy will need to be skillfully managed if the economy is not to be gored,' he added.

The IMF's latest forecast for the world's biggest economy in 2007 was down from the 3.1% given in July and 3.3% in April, and would be worse than the annual average pace over 2003-2005 of 3.2%. But it would still beat every other member of the Group of Seven club of industrialised nations except Canada, whose economy is seen by the Fund as growing 3% next year.

'Underlying this forecast is the expectation that consumption and residential investment growth will slow further as the housing market weakens, but that business investment should rebound against the background of strong profits and limited spare capacity,' the IMF report said.

However, it warned that risks to the 'soft landing' avidly sought by US policymakers were growing. 'The forecast housing slowdown is well and truly here with house price appreciation close to zero,' Rajan said.

'Rising inventories of unsold houses suggest things will get  worse before they get better, though rapidly slowing housing construction suggests that the supply side is also responding appropriately,' he added.

At the same time, the housing slowdown has yet to translate into significantly lower consumption, helped by robust labour income and lower petrol prices, he said.

Data in recent weeks have shown property sales and prices, after  booming for years, falling across the US. The slowdown apparent in housing and other sectors has encouraged the Fed to believe that inflation, while stubbornly high now, will moderate over time.

The IMF, however, said that price pressures continue to build as spare capacity in product and labour markets diminishes. The core US consumer price index rose at an annualised pace of  3.5% over May-July, its fastest pace since mid-1995, as  ky-high energy prices belatedly fed through into the wider economy.

The Fund agreed that the Fed will have to rely on incoming data to chart its course after the bank last month left its headline  interest rate steady at 5.25% after 17 consecutive  hikes.

The IMF forecast US consumer price inflation would accelerate to  3.6% this year before moderating to 2.9% next. 'Nevertheless, given the importance of keeping inflation expectations firmly in check, some further policy tightening may still be needed,' it cautioned.

More fundamentally, the IMF reprised its regular calls for George W Bush's administration to fix its deficit-ridden budget  faster and deeper than planned.