The US economy is likely to “stagnate” in the second half of this year, the IMF warned on Friday, as stock markets in the US and Europe fell to their lowest levels since March.

- 21 / 06 / 2008 09:58

The US economy is likely to “stagnate” in the second half of this year, the International Monetary Fund warned on Friday, as stock markets in the US and Europe fell to their lowest levels since March and US bank shares hit a five-year low.

The Dow Jones Industrial Average closed below 12,000 for the first time since March, while the broader S&P 500 fell 1.9 per cent, as oil rallied and concerns about the financial sector intensified.

The S&P financials index hit its lowest level since April 2003, 5 per cent below its March low.

Commercial and regional banks have borne the brunt of the recent pullback, because of fears about rising housing and consumer debt delinquencies.

The IMF said continued economic weakness would result in inflation risk going down, not up, in the coming months, and urged the Federal Reserve to keep interest rates on hold for the time being – challenging market expectations that rate increases will soon be required.

The IMF also suggested that the dollar had declined to a level at which it was closer to, if not at, its medium-term equilibrium value, on a broad trade-weighted basis.

John Lipsky, second-ranking IMF official, said: “We anticipate the economy will slow to virtual stagnation in the second half of the year.”

The IMF is now forecasting no growth at all in the US this year, measured from the final quarter of 2007 to the final quarter of 2008.

That is a modest upgrade from its prior projection, but it remains far below the average of private sector and US authorities’ forecasts.

Lipsky said the IMF does expect that growth will start to pick up in 2009 but said that recovery will be “gradual rather than aggressive”.

Friday’s financial sector weakness followed a barrage of negative earnings and ratings downgrade news this week.

Morgan Stanley fell 3.8 per cent yesterday after reporting a slump in profits and credit losses from a suspected rogue trader on Wednesday.

Citigroup fell 4.3 per cent after saying on Thursday that it would report substantial second-quarter writedowns linked to mortgages.

Further downgrades for bond insurers MBIA and Ambac and forecasts of rising losses at mortgage finance groups Fannie Mae and Freddie Mac cast a wide shadow over the sector.

Financial Times