Chances Rise for Housing Driven Recession

By Eddyson Lugangwa Posted 28 June 2006 @ 03:29 pm EET     Print     Reprint     E-Mail     Comments

WASHINGTON (Reuters) - The U.S. housing market is now tracing a clearly downward trajectory that economists say will steepen as interest rates rise, raising chances of a recession by early 2007. The key will be the extent to which the slowdown in sales activity translates to a decline in selling prices, eating away the cushion of home wealth and spending power that U.S. consumers have accumulated in recent years.

Merrill Lynch economists say there is now about a 40 percent chance of a recession in the first half of 2007 even without a widely anticipated 25 basis-point Federal Reserve rate hike this week.


As much as half of U.S. economic growth is now directly or indirectly related to housing sales, construction and consumer spending fueled by home equity extraction, said Sheryl King, senior economist at Merrill Lynch.

"If that stimulus is withdrawn, it provides a notable danger to economic growth," she said. "The higher the interest rates go, the higher the chance that the housing market cools more abruptly and you get an outright decline in home prices."

Bernard Baumhol, executive director of The Economic Outlook Group in New York, said he believes chances of a recession in 2007 will increase to 35 percent if the federal funds rate at 5.0 percent going into this week's Fed policy meeting exceeds 5.5 percent. "If the Fed gets to 6 percent, we're probably talking about a 50 percent probability of a recession in 2007," Baumhol said.

"The reason for that is that the Fed is raising rates at a point when the economy is already slowing down and past rate hikes have not yet had their full restrictive effect."