IMF to US: Economy sounder, but ditch the sequester

IMF says spending cuts 'ill-designed.' IMF urges Congress to cancel the $85 million sequester cuts and reform Social Security instead.

The U.S. economy is on sounder footing than it was a year ago but is still being restrained by government spending cuts and tax increases, the International Monetary Fund said Friday.

The IMF's annual report on the U.S. economy noted that the underlying fundamentals are gradually improving: Home prices and construction are rising, household finances have strengthened and employers are steadily adding jobs. The outlook was much more optimistic than IMF's 2012 report.

"There are signs that the U.S. recovery is gaining ground and becoming more durable," Christine Lagarde, theIMF's managing director, said in a written statement.

Still, the IMF forecasts economic growth of just 1.9 percent this year, the same as its April forecast. That would be down from 2.2 percent in 2012. And it's below many private economists' expectations that the U.S. economy will grow more than 2 percent this year.

The IMF says the tax increases and spending cuts that kicked in this year will shave about 1.5 percentage points from growth. The international lending organization had opposed the steep federal spending cuts that began on March 1.

The reduction in the U.S. budget deficit "has been excessively rapid and ill-designed," the IMF's report says.

Congress should cancel the $85 billion in spending cuts, the report urged, and replace them with longer-term reductions in entitlement programs, such as Social Security, that would weigh less on the economy.

The IMF also expects the Federal Reserve will maintain its bond purchases through the end of the year and will "very gradually" reduce them next year. The bond purchases are intended to lower long-term interest rates and encourage more borrowing, investing and spending.

Some economists expect the Fed may begin to reduce its purchases as early as its September meeting.

But Lagarde argued that "there is no need to rush," given that unemployment is still high and inflation low.

Fed policymakers will meet June 18-19 and may provide some hint of their intentions. Chairman Ben Bernanke will also hold a press conference after the meeting concludes.

Despite the drag from higher taxes and spending cuts, the IMF paints a much brighter picture of the U.S. economy.

A year ago the IMF warned that the recovery was "tepid," job growth was slow and U.S. households were still cutting debts.

Now, it sees consumers in better shape and the job market slowly strengthening. After the impact of the tax increases and spending cuts fade, growth should accelerate next year to 2.7 percent. That forecast also assumes that Congress and the White House agree to lift the government's borrowing limit later this year.

Still, the IMF expects unemployment will fall only gradually over the next two years. It forecasts unemployment will average 7.5 percent this year and fall to an average of 7.2 percent in 2014.

The unemployment rate is currently 7.6 percent — 0.6 percentage points lower than a year ago.

The economy is also being held back by weakness overseas, the report said, which are slowing U.S. exports, particularly to Europe.