United States Could Go Into Recession, Warns Oecd

The west's leading economic thinktank yesterday urged America's central bank to insure against the prospect of recession with an immediate cut in interest rates as it emerged that the crash in the US housing market had left real-estate activity at its weakest since the economy was brought to a halt by the terrorist attacks on 9/11.

Updating its half-yearly forecasts for the global economy, the Paris-based Organisation for Economic Cooperation and Development added to growing pressure on the Federal Reserve to ease the pressure on US borrowers when it meets later this month.

The OECD expressed concerns about the knock-on impact on the world economy from the credit crunch triggered by the losses sustained by financial institutions as a result of defaults on home loans to Americans with poor borrowing records and said it could not rule out a recession if an imminent slowdown in the world's biggest economy turned out to be worse than expected. "Downside risks have become more ominous," the OECD's chief economist, Jean-Philippe Cotis, said in a statement.

The OECD has penciled in a sharp reduction in the pace of growth in the US in the second half of 2007. "Our diagnosis is a slowdown. We cannot rule out a recession," Mr Cotis said.

The OECD admitted the credit crisis had taken it by surprise. "What we had not forecast was the extent of the spread of this financial risk beyond the boundaries of the US," Mr Cotis said.

Within hours of the OECD issuing its call for lower US interest rates, Wall Street was taken aback by news that pending sales of already-owned US homes fell by 12% in July to their lowest level since September 2001. The Dow Jones Industrial Average plunged 173 points to 13,275 in early trading. The dollar fell sharply on the foreign exchanges as dealers expressed concern that the pace of decline in the housing market was accelerating even before the tightening of credit conditions seen in August.

Ian Shepherdson, economist with High Frequency Economics, said the decline in the pending sales index in the past three months had been the steepest since the market started to turn down two years ago. "This is disastrous," he added.

The OECD has cut its forecast for growth in the US this year from 2.1% to 1.9%, but said its prediction did not take into account the impact of the financial market turmoil of the past month, a period which has seen signs of a credit crunch in all parts of the globe.

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

In the rest of the world, the OECD raised its forecast for UK growth this year from 2.7% to 3.1%, left Japanese growth unchanged at 2.4% and slightly trimmed its forecast for the Eurozone from 2.7% to 2.6%. Mr Cotis said the European Central Bank should delay raising interest rates until the financial markets had become calmer and that the Bank of Japan needed to worry more about deflation than inflation.

The OECD offered no advice on rates to the Bank of England, which will announce its latest decision today.

In a separate report yesterday, a United Nations agency said that developing countries could struggle to lift themselves out of poverty unless a new international body is set up to monitor exchange rates and reduce huge global trade imbalances. The United Nations Conference on Trade and Development's latest report said exchange rates can no longer be left to market to decide due to the effects of "carry-trades".

These happen when big investors such as hedge funds are able to trigger an appreciation in the exchange rate of a country with a high interest rate such as the US by shifting assets from a currency with a low interest rate such as the Japanese yen.

"The crisis we have seen in the US mortgage market shows how volatile financial markets are.

"This volatility needs the fire brigades of central banks to fight it all the time," said Heiner Flassbeck, UNCTAD's chief economist and author of the study.

He added that the same approach was needed when dealing with speculation in international currencies which were distorting the competitive position of nations, especially developing ones.

"Markets don't always get it right. This carry trade phenomenon is very important. It shows that the market system can get it wrong all the time and then only through shocks can the system be corrected."