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US economy shrinks at fastest pace in seven years

The US economy contracted at its fastest pace in seven years in the third quarter as consumer spending plunged to a 28-year low, data showed, raising the specter of a deeper recession.

Separate reports showed US home prices continued their downward spiral, with the cost of single-family homes plunging by a record 17.4% in September from a year earlier.

The data painted a dismal picture of the troubled economy and backed views the Federal Reserve could push benchmark lending rates to an unprecedented 0% by early 2009.

“We are in the early stages of one of the worst recessions in the post-war period, even factoring in a massive stimulus program,' said Nariman Behravesh, chief economist at IHS Global Insight in Lexington, Massachusetts.

The grim reports partially overshadowed the Fed's announcement that it would use up to $800 billion to buy mortgage-related debt and consumer debt securities. The Dow Jones industrial average ended up 36.47 points at 8,479.86, after a choppy session.

US government debt prices rallied, helped by a safe-haven bid fueled by the worsening outlook. The dollar, however, fell a third session against the euro, handing the European single currency its best three-day percentage advance ever.

The Commerce Department revised the annual rate of decline in third-quarter gross domestic product to 0.5% from the 0.3% that it reported a month ago. It was the sharpest fall in GDP since the third quarter of 2001, in the aftermath of the September 11 attacks.

Corporate profits dropped for a second straight quarter and business investment fell for the first time since the end of 2006, signaling a wariness about prospects for future sales.

Consumers, hard hit by rising unemployment and plunging home equity, held back and sent spending falling at its sharpest rate since the second quarter of 1980. Consumer spending accounts for two-thirds of economic activity.

Many analysts believe the United States already has joined Europe in recession, though it will take another quarter of contraction to meet a widely used definition for it - back-to-back quarters of declining output.

The third-quarter decline in GDP was a striking contrast with the second quarter's relatively brisk 2.8% rate of growth. The US economic decline is widely predicted to accelerate in the fourth quarter and last into 2009.

The White House blamed the contraction in the economy on the credit crisis that has emanated from the collapse of the US housing market.

“There's no question the financial crisis was a major shock to the economy, and that's being reflected in the economic data. We believe a big reason for this was the freezing in credit markets this fall,” said White House spokesman Tony Fratto.

“That's why we've been so focused on unfreezing our credit markets and stabilizing our financial system.”

The housing malaise has infected other sectors of the broader economy, translating into the highest unemployment rate in 14 years and a record drop in retail sales. Steps by global authorities, including the Federal Reserve's interest rate cuts, have had limited impact in freeing up credit and stimulating demand.

Analysts reckon the US central bank could trim the overnight federal funds by another half point at its next meeting in December after an aggressive easing campaign that has already pushed it down to 1.0% from 5.25% over the past 14 months.

“Today's numbers tell us that the economy is probably in a long and deep recession, probably half way through that. We still have a lot of water under the bridge,” said Cary Leahey, senior managing director at Decision Economics in New York.

“We see the Fed cutting another (half point) in December and following up with another quarter of a% immediately after ... maybe down to almost zero then,” he said. After that, the Fed will turn to an unconventional policy of flooding the banking system with excess cash, Leahey said.

An uptick in the Conference Board's consumer confidence index to 44.9 from in November from 38.8 in October did little to brighten the mood.

“The confidence index is still at the lowest level on record since 1975 and is clearly below its worst levels in each of the past four recessions,” said Yelena Shulyatyeva, an economist at BNP Paribas in New York.

Further highlighting the deteriorating economic climate, prices of US single-family homes in September plunged a record 17.4% from a year earlier, the Standard & Poor's/Case-Shiller Home Price Indices showed. (Reuters)