U.S. economic forecast for 2008: Bleak

The housing crisis and high oil prices may cause a slump, analysts warn.

The outlook is for a rocky time ahead for the US economy as it moves into 2008.

Many economists predict that America will move closest to a downturn since the current expansion began seven years ago. If the economy does contract, economic seers expect a shallow retrenchment, most likely in the first six months of the year. Most see only limited improvement in the latter half.

A lagging economy is likely to have wide ramifications. In the heat of a presidential election year, unemployment would start to rise, making the economy a major issue for the candidates. An anemic economy would also present a challenge to the Federal Reserve Board, which might opt to keep cutting interest rates. Soft economic numbers, moreover, could have a detrimental effect on corporate profits – depressing financial markets and lowering tax receipts, straining government budgets.

"There is not much margin for error. It would not take much to push us over the edge," says Dennis Hoffman, an economist at the W.P. Carey School of Business at Arizona State University (ASU) in Tempe. "It's hard to come up with boom-time scenarios."

Of course economists and Wall Street have been pessimistic – and wrong – before. This past year, for example, strong exports, thanks to the weak dollar, and an unexpected inventory buildup resulted in a surge of 4.9 percent growth in the third quarter, much higher than the forecasts.

"The biggest surprise of the year is how resilient the economy has been in the face of [skyrocketing] oil prices," says Robert MacIntosh, chief economist at Eaton Vance, a mutual-fund group in Boston. "Consumers have barely blinked."

Behind the dim forecasts for next year are some of the same factors that beset the US economy this year: stress in the housing market and relatively high oil prices. These twin problems will, in 2008, finally get to the consumer, say economists.

"Consumer spending in 2008 will slow to a 1.8 percent pace, but it could be below 1 percent," forecasts Scott Anderson, chief economist at Wells Fargo in Minneapolis. "The first half will feel like a recession for consumers."

It already feels like that in Arizona, says Professor Hoffman at ASU. "We lead the nation in employment growth – some 3 percent more people come here each year," he notes. "But our spending patterns this year are really negative, the worst in 15 years. For example, we're seeing automobile sales off by double digits."

Unlike some previous years, the economy will have little momentum leading into 2008. Retail analysts believe holiday sales rose by no more than 4 percent, one of the slowest rate increases since 2002.

As was the case this year, one of the strongest head winds buffeting the economy will be problems in the housing market, economists say. Sales of new homes are expected to continue to fall as builders try to shed inventory. Few forecasters expect to see home prices rise, or even stabilize, next year. Instead, estimates of a further decline in value range from 3 to 6 percent.

"In some places, such as southern California, there will be double-digit declines for the second year in a row," says Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh. "If the national trends showed housing prices falling 8 to 10 percent, that would be enough to send us into a recession."

The manufacturing segment of the economy is already in a recession, says Daniel Meckstroth, chief economist at Manufacturers Alliance/MAPI in Arlington, Va. Manufacturing production will fall 2 percent in the last quarter of 2007, he estimates. "Auto sales are poor. Wood products, furniture, glass, hardware are all declining, and I think there is now a snowballing on the downside that is dragging down other markets."

Dr. Meckstroth blames the housing collapse, near-record oil prices, the credit crunch, and slowing employment trends.

"One or two of these would not cause a recession, but the combination of all of them does it," he says.

He is concerned that losses in the banking system will stifle the economy. With an estimated $200 billion in losses in the housing arena, the banks need to increase their reserves, Meckstroth says. This could reduce the availability of money for new loans. "The banking system is very fragile right now," he says.

Economists expect that the Federal Reserve will continue to cut interest rates because of recession concerns. The Fed's next meeting is Jan. 29 and 30.

"I think they will cut rates but maybe more quickly and deeply if energy prices are down," says Mr. Hoffman of PNC. "But if energy prices are up, the Fed's in a real dilemma."

The computer models at Standard & Poor's indicate that the price of a barrel of oil should fall by about $20 to the neighborhood of $75, says David Wyss, chief economist at S&P.

But he is skeptical of those forecasts of lower oil prices, because prices have remained high. On Thursday, for example, the price was as high as $96.50 a barrel, up from $93 a barrel on Monday.

Analyst Jennifer Gordon of Deutsche Bank, in a message to clients on Thursday, predicted the price will soon rise above $100 a barrel as a result of political unrest, a falling dollar, and falling inventories. "Oil over $100 a barrel in the next few days," she writes.

"If oil prices remain high, it's possible retail gasoline prices could hit $3.50 a gallon nationally by July 4," predicts Mr. Wyss. Currently, regular gasoline is about $2.97 a gallon, according to GasPriceWatch.com.

Economists expect gasoline prices and the economy to become a more important factor in the election campaign. ASU's Hoffman says that, in the last two presidential elections, consumers became so distracted by the campaign that they hesitated to make major purchases.

"We call it the CNN effect," he quips. "This is going to be really tough with a fragile economy. It's not going to play out well."