AP survey: A bleaker outlook for economy into 2011

[July 29, 2010]  WASHINGTON (AP) -- The U.S. economic recovery will remain slow deep into next year, held back by shoppers reluctant to spend and employers hesitant to hire, according to an Associated Press survey of leading economists.

The latest quarterly AP Economy Survey shows economists have turned gloomier in the past three months. They foresee weaker growth and higher unemployment than they did before. As a result, the economists think the Federal Reserve will keep interest rates near zero until at least next spring.

Yet despite their expectation of slower growth, a majority of the 42 economists surveyed believe the recovery remains on track, raising hopes that the economy can avoid falling back into a "double-dip" recession.

The AP survey compiles forecasts of leading private, corporate and academic economists on a range of indicators, including employment, consumer spending and inflation. Among their forecasts:

- Economic growth the rest of this year and early next year will weaken, to less than 3 percent. From January through May, the economy grew at roughly a 3.5 percent pace.

- The unemployment rate will be no lower at the end of the year than it is now -- 9.5 percent. A majority think it will be 2015 or later before the rate falls to a historically normal 5 percent.

- State budget shortfalls pose a "significant" or "severe" risk to the national economy. The loss of tax revenue has forced state and local governments to cut services and lay off workers.

The weak economy leaves Democrats and Republicans on Capitol Hill vulnerable as they head into the November midterm elections. Democrats, who now control both chambers, have the most to lose. The gloomier outlook is also a liability for President Barack Obama.

The economists have turned more pessimistic since the recovery hit turbulence in May. Europe's debt crisis sent tremors through Wall Street, causing stocks to tumble and raising doubts about the durability of the rebound.

Since then, businesses have been slow to step up hiring. Americans' confidence in the economy has declined, leading shoppers to reduce spending. And the housing market has weakened further with the end of a homebuyer tax credit that had buoyed sales earlier this year.

Consumers aren't leading this rebound, as they usually do, despite ultra-low borrowing costs. Their spending growth will weaken in the second half of this year and strengthen only slightly next year, a majority of economists said. They think shoppers' reluctance to spend more money poses a "significant" or "severe" risk to the recovery.

"It seems like we hit an air pocket in consumer spending," said survey participant Richard DeKaser, president of Woodley Park Research.

Kasey Doshier, a graphic designer in Chicago, said the recession taught her to rein in her spending. The key moment came early last year, when her employer cut her pay 15 percent to avoid layoffs.

"I just lived paycheck to paycheck and had a good time," said Doshier, 32. "It's kind of scary to think that I am a paycheck away from being homeless."

Doshier's pay has been reinstated, but she's still watching her money. Dinner and drinks with friends are gone. Now she goes to free street festivals and the city pool. She explores Chicago neighborhoods by taking her dog on long "adventure walks."

The tight job market, scant pay raises and drooping home values are forcing others, too, to spend less and save more. Americans saved 4.2 percent of their disposable income last year. That was the highest level since 1998. Economists expect roughly the same level of saving this year and next.

That's why growth of less than 3 percent is forecast into 2011. And weak growth helps explain why unemployment is likely to stay high. It takes about 3 percent growth just to create enough jobs to keep pace with the population increase.

Growth would have to equal 5 percent for a full year to drive the unemployment rate down by 1 percentage point. Neither the economists in the AP survey nor the Obama administration expects that to happen.

The Fed's outlook has turned bleaker, too. It's why Chairman Ben Bernanke and his colleagues are weighing new steps to invigorate the economy if the recovery shows signs of backsliding. They are also expected to hold interest rates at record lows longer than economists thought three months ago.

A survey the Fed released Wednesday showed the economy facing a bumpy path back to health. The pace of economic activity remained modest in most of the country.

Most economists surveyed said the Fed would being raising short-term rates no sooner than next spring. In the last survey, most had thought it could happen as soon as late this year.

At the same time, state budget shortfalls have emerged as a major threat in the economists' view. State and local governments cut their spending in the first three months of this year at a 3.8 percent pace. That was the biggest cutback since the second quarter of 1981, just before the economy entered a severe recession.

When states and localities tighten spending by trimming services and jobs, the cutbacks ripple through the broader economy, causing individuals to spend less, too. The drop in state and local government spending shaved about half a percentage point off the U.S. gross domestic product in the first three months of this year.

Nearly two-thirds of the economists view the states' budget crises as a significant or severe threat to the rebound.

Despite such risks, 55 percent of the economists described the recovery as "on track" as of the middle of the year. The rest said it was "faltering."

"There's a risk that the loss of momentum will snowball and feed on itself, but I think in the end the recovery will stay on track," predicted another survey participant, James O'Sullivan, global chief economist at MF Global.

[Associated Press; By JEANNINE AVERSA]

AP Business Writer Christopher Leonard in St. Louis contributed to this report.

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