OECD says recovery still at risk

PARIS, France (Reuters) -- The United States is leading the world out of 2001's sharp economic downturn but recovery remains at risk if oil prices rise or stock markets drop when company profits lag excessive expectations, the OECD said on Thursday.

In a twice-yearly Economic Outlook report, the Organisation for Economic Co-operation and Development said the outlook for economic growth and world trade looked considerably brighter than it did after the September 11 attacks on U.S. cities.

The Paris-based OECD predicted U.S. growth of 2.5 percent this year and 3.5 percent in 2003 after an estimated 1.2 percent in 2001, with Europe also recovering and Japan eventually pulling out of protracted recession.

"In the absence of further large-scale terrorist aggression, the net long-term macro-economic impact of the September 11 shock is probably tangible but limited," the OECD said.

"Uncertainty is marginally higher, and so are transaction and security costs," it said, highlighting higher insurance costs, greater focus on defence spending and hindrances to trade from additional controls at airports and shipping terminals.

Illustrating the degree to which the OECD believed the U.S. economy was back in flying form, chief economist Ignazio Visco told a news conference he expected very strong figures this week on U.S. growth in the first quarter of 2002.

He even suggested the government and central bank would need to adapt policy to prevent overheating.

"Perhaps the expansion may be gaining too much," he said.

The OECD said it expected the U.S. Federal Reserve to start raising interest rates from around the middle of the year after massively slashing benchmark credit costs last year to counter the downturn that hit well before September 11.

It said it saw the European Central Bank doing likewise for the 12-nation euro zone, but advised it to wait until recovery was better established, by the end of the year.

With Japan hit by deflation and interest rates near zero, the world's second biggest national economy had little room for manoeuvre and the best thing Japan could do to boost business was to sort out massive bad loans in the banking sector.

The OECD predicted growth of 1.3 percent this year in the euro zone, with the pace of recovery accelerating towards the end of the year, and of 2.9 percent growth in 2003.

In Japan, it predicted further shrinkage of 0.7 percent this year, followed by a rebound as world trade picked up, producing marginal expansion of 0.3 percent next year.

It said other Asian economies had weathered the downturn well and that growth in China was expected to expand again by some seven percent this year. Other large economies such as Russia had slowed but shown some resilience too.

The OECD said there had been little knock-on effect in neighbouring countries to the crisis in Argentina, which has devalued its currency at stopped servbicing its $141 billion external debt following a four-year recession.

"Latin America presents a mixed picture, but in general the Argentine crisis has had limited spillover effects on other countries in the region," it said.

"Overall, the recovery both inside and outside the OECD area is likely to boost world trade growth from 2 1/2 percent in 2002 to over nine percent in 2003," it said.

The OECD, whose 30-country membership represents the bulk of the world's wealth industrialised economies, said the biggest risk to growth was high oil prices due to continued tension in the Middle East.

Its forecasts were based on assumptions of an oil price of $25 a barrel on average this year and next, but it said it was impossible to rule out higher levels.

The OECD also said stock markets appeared to be expecting excessive rebounds in corporate profits and that the recent stabilisation in share markets could unravel.

"While share prices are well below their 2000 peaks, concerns remain over high price/earnings ratios...market expectations appear to be for double-digit increases in profits," it said.

"There is a clear risk that profits will be less buoyant and that market expectations will be disappointed," it said.

European stock markets dropped for the fourth straight day on Thursday as disappointing results from British insurer CGNU and telecoms group Vodafone sparked wider selling, compounded by a surprise drop in Germany's influential Ifo business confidence index.