WASHINGTON, July 31 (Reuters): The US economy is in unchartered waters and the economy is likely to underperform through the middle of next year in the face of a worsening housing and credit crisis, the International Monetary Fund (IMF) said Wednesday.
With US house prices falling sharply and because recovery from a housing bust is often slow, the IMF said the Federal Reserve should keep interest rates on hold for now, even though inflation concerns are rising.
"Concerns about activity would need to be much more pronounced to justify a more accommodative stance," IMF staff said in a report outlining its consultations with the US Treasury and the Federal Reserve.
"The case for a preemptive hike in policy rates, as markets now anticipate, is ... unclear," it added.
The IMF raised its economic growth projections for the United States on July 17 to 1.3 per cent in 2008, up from the 0.5 per cent it estimated in April. It forecast 2009 growth would be 0.8 per cent, up from its prior estimate of 0.6 per cent.
An IMF official said the US economy has been more resilient than expected but still faces difficult times ahead because the housing turmoil weakens household demand and worsens credit conditions.
The IMF said US Treasury officials argued that the flexibility of the US economy and support from strong corporate balance sheets, external demand, and economic stimulus would spur a recovery in the second half of 2008.
The IMF said the US dollar's decline has moved the currency closer to medium-term equilibrium, but staff estimated that its value is still somewhat on the strong side.
Using different methodologies, the IMF said the dollar was still overvalued by between 0 per cent and 10 per cent in real effective terms.
"Given the state of our understanding and knowledge I would say it is pretty close to equilibrium," an IMF official told the conference call with reporters.
IMF staff said while US officials did not take a position on the level of the dollar during discussions, they believe the dollar "has moved in line with fundamentals, including interest rate differentials and relative output."
Still, several IMF directors noted that the dollar's depreciation was greater against mostly free-floating currencies like the euro, than against currencies of countries with large current account surpluses, such as China.
The IMF said the expansion of US mortgage guarantee programmes could prevent excess home price declines, and IMF officials said they supported legislation passed by Congress aimed at resurrecting the housing market.
The law, signed by US President George W Bush Wednesday, launches a $300 billion government initiative to refinance troubled mortgages, and boosts oversight of housing finance providers Fannie Mae and Freddie Mac, which own or guarantee almost half of the country's $12 trillion in home mortgage debt.
"We strongly support the initiative given the importance of minimising preventable foreclosures, but we have concerns about the actual take-up of what is being offered," the IMF official said. "The decision of lenders to write down mortgages and modify their terms is voluntary, and the question is, Are there sufficient incentives for lenders to do so?"
The IMF said fiscal stimulus measures to boost the economy were well timed, but any further action should provide temporary support to housing and financial sectors at the root of problems.
In response, some US officials said targeted spending packages could delay an adjustment in housing and asset prices and may be perceived as "bailing out" reckless behavior. Others, however, said in the case of a further downturn there could be a role for some limited measures.
Meanwhile, the Federal Reserve took further steps yesterday to battle a global credit crunch, including an extension of an emergency lending programme for investment firms facing a liquidity squeeze.
The Fed said it took the actions "in light of continued fragile circumstances in financial markets."
In addition to the extension of credit to investment banks, the Fed said it would lengthen the terms of another programme to help retail banks meet funding needs, and extend reciprocal credit arrangements with the European Central Bank (ECB) and Swiss National Bank to help European banks get dollar funding.
"The programs are designed to combat systemic risks to the financial system related to short-term funding pressures-pressures that can be significantly exaggerated by contagion and speculative bandwagon effects," said economist Brian Bethune at Global Insight.
"These pressures re-emerged at the end of June and in early July-the fourth episode of severe pressures in the financial markets since the crisis erupted in US and European financial markets in August 2007." The US central bank will extend past the original September expiration date to January 30 a programme aimed at helping get liquidity to so-called primary dealers, big investments firms which have a relationship with the Fed.
