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Economy still facing recession, rebound seen tepid

The US economy is still facing a possible recession this year, with any recovery stunted by inflation that prevents the Federal Reserve from cutting interest rates again, according to a Reuters poll.

The Fed has already slashed rates by 3.25 percentage points since September to fight the effects of a housing slump, a drag on spending from record oil prices and four consecutive months of job losses.

The latest poll of over 100 economists, taken May 15-21, was moderately more upbeat than one taken a month ago, in part because first quarter economic growth, at an annualized 0.6%, was not as bad as many had feared.

They now see growth at 1.2% this year on a fourth-quarter over fourth-quarter basis, slightly above last month's forecast of 1.0%. The median forecast is also at the upper end of the Federal Reserve's own central range published on Wednesday.

But they expect the economy will contract in the current quarter by an annualized 0.3%, though they were split on whether or not it will slip into recession, putting a median 50% probability on such an outcome.

That compares with the April survey, where 42 of 58 economists who answered the question said the US was already in the beginning of a recession, usually defined as two quarters of negative economic growth.

But economists agree any rebound, recession or not, will be lackluster. They revised down growth expectations for the third quarter to 1.6% from 2.0% and for the fourth quarter to 1.2% from 1.6%.

“The depth of the recession remains to be seen but the recovery, when it comes, is likely to be tepid at best,” said Richard Iley, senior economist at BNP Paribas in New York.

The poll predicted core inflation - excluding food and energy - would be 2.3% this year, down from the 2.4% they predicted in April and the first time that core CPI expectations for 2008 have been downgraded since September. For next year, they kept their forecast steady at 2.2%.

Analysts expected consumer price inflation to remain stubbornly high in the near term, at 3.8% in the second quarter, and 3.9% in the third before dropping to 3.2% in the fourth quarter.

For all of 2008 headline inflation is set to average 3.7%, above the 3.5% predicted in last month's survey. Their prediction for 2009 is 2.4%, also above April's forecast of 2.3%.

Economists mostly agree now that the Fed no longer has the leeway to cut rates, reversing the previous month's consensus forecast for further easing below the current 2.0%. They expect them to stay on hold until the middle of next year and then rise to 2.50% by end-September 2009.

The series of rate cuts so far have weakened the dollar and boosted exports, but also have contributed to a rise in inflation that is becoming ever more worrisome with crude oil at $135 a barrel and rising.

Last month, economists expected one more interest rate cut to take the benchmark federal funds rate down to 1.75% this quarter.

However, rhetoric from Fed officials has made clear they are concerned about inflation and would like to assess the effects of their previous cuts before considering any more.

Federal Reserve Vice Chairman Donald Kohn said on Tuesday the US central bank did not want to create the perception that it would tolerate higher inflation. (Reuters)