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Economic Outlook December 20, 2007, 5:00PM EST

No Recession, But…

Most experts we polled expect growth, however meager, in 2008. A few predict rougher times

By James C. Cooper

For 2008, the economic outlook is Topic No. 1 for almost all investors. Stock prices and bond yields already reflect recession worries, but an actual downturn would hit portfolios hard. To help get a handle on what to expect, BusinessWeek asked 54 forecasters in our annual outlook survey for their views on everything from housing and the credit crunch to Fed policy and global growth. (Click here for full survey results.)

The bottom line looks like this: The economists project, on average, that the economy will grow 2.1% from the fourth quarter of 2007 to the end of 2008, vs. 2.6% in 2007. Only two of the forecasters expect a recession, although it might feel like one if there's sluggish growth over the next couple of quarters, as many predict. Almost all think the risk of a downturn has risen substantially in recent months.

As a group, the forecasters say slow growth will lift the jobless rate from 4.7% in November to 5.1%, and it will hold down inflation. As oil prices level off or decline, the yearly growth in consumer prices will slide from 4.3% in November to 2.4%, while core inflation, which excludes energy and food, will hold steady at a tame 2.2%. Profits will grow in the low single digits. Home prices will fall about 7%, but housing starts will bottom out by midyear.

Almost all "no recession" forecasts are predicated on further rate cuts by the Fed. The target rate is expected to drop from 4.25% to between 2.5% and 4%, with almost half of the analysts projecting it to fall below 4%. The yield curve will steepen a bit, as 10-year Treasuries edge up to 4.5% by yearend.

On balance, the analysts are cautiously optimistic, but with plenty of hedging amid all the uncertainties. Here's how they see the hot-button issues shaping up:

THE CREDIT CRUNCH

Perhaps the biggest surprise of 2007 was the way the housing slump shook the economy. It wasn't just the direct drag of less construction activity, the shrinking outlays on home-related goods, and lost consumer wealth, as economists had expected. It was the way the subprime debacle hit the financial markets, setting off two things: a new downturn in housing activity and a liquidity crisis that now threatens a broad squeeze on credit availability. "The two main risks in the outlook are that sharp further declines in home prices will cause consumers to spend less, and that the ongoing credit crunch will curtail activity in a more general way," says Dana Johnson at Comerica Bank (CMA) in Dallas.

Some worry the Fed isn't doing enough. "The Fed's response to the current financial market troubles and weaker economy has been slow, as they have underestimated the severity of the problem," says Mark M. Zandi at Moody's (MCO) Economy.com. Analysts are encouraged by the Fed's coordinated efforts with other central banks to auction off funds in an effort to relieve strains on liquidity. However, if key market rates, crucial to the short-term funding needs of businesses, fail to come down, most economists believe aggressive rate cutting will be the only way to protect the economy.

With help from the Fed, consumers and businesses should be able to manage the crunch. "While consumers are likely to grow more cautious in 2008, solid income growth should prevent a sharp contraction in spending," says Ethan S. Harris at Lehman Brothers (LEH). Businesses will continue to expand their outlays and payrolls, since they are not overextended with debt, excess production capacity, or inventories, and the lower dollar is providing a stimulus for exports, especially since the rest of the world is doing O.K. But without effective Fed action, the credit vise could begin to squeeze too hard.

THE HOUSING SLUMP

When will the vicious cycle of falling home prices, mortgage defaults, and credit tightening be broken? "

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