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Experts: Housing, energy key to economic outlook

WASHINGTON—Analyzing the economy these days is like trying to read faint signals in thick fog: There are positive signs, but also troubling and sometimes conflicting signals.

The U.S. economy is sure to slow next year, but most experts say it probably won't slip into recession—though some think it could be a close call.

Housing and energy prices will probably prove decisive.

Most mainstream economists are projecting that the economy will grow at an annual rate of 2 percent to 3 percent in 2007. It averaged 3.8 percent annual growth from 2003 to 2005 and slowed in 2006 to a 2 percent annual rate in the third quarter.

A slowdown's not necessarily bad. The U.S. economy had been growing so fast that it was threatening to spark inflation, sending prices rising across the board. The Federal Reserve tried to tamp down inflation by tapping the brakes on growth with a series of 17 short-term interest rate hikes.

The Fed stopped its rate increases in August. The trick is to know when to stop before the economy stalls. It's a delicate task involving judgment and luck, because there's a lag between the Fed's actions and the economy's response.

Now the economy is responding with mixed signals.

On the positive side, stock and commodities markets were on a tear in 2006. The Dow Jones industrial average hit record highs repeatedly through December. It's been a good year for Americans whose retirement fortunes depend on the stock market.

But while stocks are soaring, residential real estate is in reverse. For the first time since the Great Depression, home prices nationwide posted a year-over-year decline.

New home starts are expected to have fallen 17.7 percent in 2006 and drop another 9.4 percent next year, according to the National Association of Realtors. Existing home sales are expected to have fallen 8.6 percent this year and drop another 1 percent in 2007.

Historically, recession follows a sharp downturn in housing. Yet few economists put the chance of recession at better than 1 in 5.

"Housing is in a recession. The good news is it isn't dragging down the rest of the economy," said Nariman Behravesh, chief economist for Global Insight, a forecaster in Lexington, Mass.

That's because U.S. companies are flush with cash, consumers are still spending and employment remains strong.

"We're seeing solid consumption growth. It just does not look like the U.S. consumer is going away," said Martin Regalia, chief economist for the U.S. Chamber of Commerce.

Consumers spent more in November than they had since July, the Commerce Department reported recently, the latest reassuring news that a slump isn't imminent.

A spike in energy prices could stop that in a hurry, however, tipping the entire economy into the tank.

"The real risk is if there were to be a serious disruption in the Middle East, in which 5 million barrels per day was taken off the market for a month or two. That could mess things up," Behravesh said.

Oil prices are well off the year's high of $78.40 in July, but after dipping below $60 a barrel, they now hover around $63, owing to concerns that global supplies may grow tight. The Organization of Petroleum Exporting Countries intends to keep supplies tight if it can to ensure that prices remain above $60 a barrel.

Despite the housing slump and oil price volatility, consumer confidence didn't wane much in 2006. Consumer spending tracks the labor market—people with jobs spend money. And an unemployment rate of 4.5 percent signals an economy close to full employment.

"Job Growth Supports Consumer Spending," was the headline of a mid-December analysis by Gary Thayer, chief economist for A.G. Edwards & Sons Inc. Thayer wrote that "good corporate profit growth and healthy job growth are supporting the economy despite the recession in housing."

Former Federal Reserve Chairman Alan Greenspan recently predicted that the worst was over for housing, and thus for the economy. But what if Greenspan is wrong and the housing slump begins to curb consumer spending?

"If the worst is not over, then the swiftness and severity of any further unwinding will weigh heavily on the timing of the next recession," wrote James Stack, a stock-market historian and president of Stack Financial Management, in a mid-December analysis.

Never before has residential construction spending turned so negative without signaling recession, he wrote, adding that it's premature to assume that the once-overheated national housing market has corrected itself.

"This could just as easily be a temporary blip or the start of a painfully long plateau," Stack cautioned.

Sharing that concern, Merrill Lynch's chief economist for North America, David Rosenberg, put the chance of recession in 2007 at a relatively high 55 percent. He believes the housing slump will spill over into the broader economy next year. His forecast calls for an anemic annual growth rate of only 1.7 percent.

That's more dire than the predictions of most economists, who cluster around a growth projection of about 2.5 percent for 2007.

"The principal reason for optimism is that businesses ... are in fantastic financial shape. It's very difficult to envisage businesses pulling back, at least to the degree that it would cause recession," said Mark Zandi, chief economist for Moody's Economy.com, a consultancy in West Chester, Pa. "They may grow more cautious in the face of softer demand ... but they're not going to cut payroll and slash investment."

Zandi forecasts 2.6 percent growth in 2007. He's less worried about recession than if the U.S. economy rebounds too quickly, frustrating the Fed's efforts to quash inflation.

On Dec. 19, the Labor Department reported that wholesale prices soared by 2 percent in November, the largest monthly gain since 1974. That makes Zandi's fear scenario all too credible, where the Fed would have to get more aggressive against inflation, raising interest rates to heights that risk recession.

"That to me is a palpable risk," he said. He points to other positive data, such as increased trade flows and mortgage applications. "They all suggest that maybe the economy is going to revive faster than anticipated," he said, which could push the Fed to raise rates—and risks.

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Positive signals for U.S. economy in 2007:

_ Stock market booming

_ Commercial real estate setting records

_ Corporations flush with cash, profits up

_ Mortgage rates not up wildly

_ Headline inflation falling

_ Oil prices moderating

_ Weaker dollar boosts U.S. exports

_ European and Asian growth fill global void left by U.S. slowdown

Some risks for U.S. economy in 2007:

_ Housing downturn slumps further, pinches consumer spending

_ Slowing economy yields fewer jobs, leading to weaker consumer spending

_ Iraq chaos spills into Saudi Arabia, hurting global oil supplies

_ Oil spikes above $70 a barrel and stays there

_ U.S. economy rebounds too fast, prompting sharp interest rate hikes

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A sample of economic growth forecasts for 2007:

_ President Bush's Council of Economic Advisers: 2.9 percent.

_ Business Roundtable, made up of the top 160 CEOs: 2.8 percent.

_ Moody's Economy.com: 2.6 percent.

_ U.S. Chamber of Commerce: 2.5 percent.

_ Global Insight: 2.2 percent.

_ Merrill Lynch (North America): 1.7 percent.

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(c) 2006, McClatchy-Tribune Information Services.

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