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Economy Will Be Hit Hard Even Without Recession

The U.S. economy may dodge the bullet of a recession in the year ahead but it's almost certain that there will be months of slow growth that will create hardship for many businesses and consumers.

Economists expect troubles in the housing and financial sectors to deepen, and many have cut already low forecasts for U.S. economic growth as stress in credit markets began to build anew in recent weeks.

While housing accounts for a relatively small percentage of the economy, it has a disproportionate effect on consumer behavior because of the "wealth effect." People spend more based on their perception of the value of their homes.

With real estate prices falling and credit tight, a growing chorus of economists think the world's largest economy is about to topple into recession, and even those who don't see a full-blown downturn warn of rising unemployment and potential pay cuts as businesses seek to tighten their belts.

"A recession is more likely than not at this point," said Mark Zandi, chief economist at Moody's Economy.com. "It's still very possible that we can avoid a recession, but it's going to be impossible to avoid what we view as a very weak economy through next spring -- and that will be very painful."

Even White House acknowledges recession risks have growth.

"Obviously, the chances of a recession are higher now than they were a year ago, but we still think it's less than 50:50," White House adviser Allan Hubbard, who announced on Wednesday he was stepping down, said earlier this week.

The last time the United States suffered a recession was in 2001, after a record decade-long expansion.

Rate Cut Tonic?

While the chances of a downturn have risen in recent weeks, many economists are still hopeful one can be avoided with further interest-rate cuts from the Federal Reserve.

The U.S. central bank has lowered the benchmark federal funds rate by a cumulative three-quarters of a percentage point since mid-September, and Fed Vice Chairman Donald Kohn signaled on Wednesday that another rate cut may be in the offing. That fired stocks to a second straight day of big gains, with the Dow industrials up nearly 500 points, and bonds traders were betting on a near-term rate cut.

But economists say even a shot in the arm from the Fed won't be enough to avoid a prolonged stretch of sluggish growth.

Last week, UBS cut its 2008 forecast for U.S. economic growth to 2 percent from an already tepid 2.4 percent.

"There is a vicious cycle that may well prolong things somewhat. Weaker growth typically goes hand-in-hand with a weaker labor markets," said Andrew Cates, economist with UBS in London.

And, while the strength of the global economy has given a lift to U.S. exports, world growth will also slow, adding to U.S. woes, he said.

"European banks, like the U.S. banks, are tightening up.

Credit standards are being tightened not just for corporations but for households as well," Cates said.

Can the Economy Hold Up?

So far, consumers, who fuel two-thirds of U.S. economic growth, have only curtailed their spending slightly. But as credit becomes more difficult to obtain and pay gains get more scarce, that too will change.

"In the words of (former Fed Chairman Alan) Greenspan, there's going to be a protracted period of balance sheet repair," said Cates, who predicts households will be working to reduce debt.

If consumers cut back on spending, businesses in turn will have to cut costs. Inevitably, firms will cut back on hiring and layoffs may begin to rise.

Economy.com's Zandi predicts the U.S. unemployment rate will rise significantly over the next several months from October's 4.7 percent.

"In a slow-growing economy through next summer we will be at 5.25 percent," he said. "That's millions of people, and more significant will be the cuts in pay, benefits and other compensation that almost everyone is going to struggle through."

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