The U.S. economy is mending more quickly than anticipated, although high unemployment and growing commercial property defaults will put a drag on the recovery, the International Monetary Fund said on Thursday.

In its World Economic Outlook, the IMF said it now expects the U.S. economy to grow 1.5 percent in 2010, up from its July forecast for 0.8 percent growth. It nudged down its 2009 forecast to a decline of 2.7 percent from its earlier estimate of a 2.6 percent slide.

The IMF credited unprecedented interventions by the U.S. government and the Federal Reserve with helping to stabilize consumer spending and the housing and financial markets, which likely restored economic growth in the second half of 2009.

On the upside, the strong policy response and a rapid recovery in emerging markets could lead to a virtuous circle of rising confidence, improving financial conditions, and strong aggregate demand growth, the IMF said.

But receding downside risks remain a concern.

It cautioned that consumer spending may be weaker than predicted because of high and rising unemployment and the need for households to pare debt.

Accelerating corporate and commercial property defaults also threatened to slow the improvement in financial conditions, which could hinder the rebound.

The strength and sustainability of the economic recovery will depend on three factors:

- Continued stabilization of the economy and the financial system.

- Getting the timing right on removing public support for the financial system and developing a strategy to shrink the U.S. Federal Reserve's balance sheet.

- Addressing long-term imbalances in public, household and financial balance sheets.

With unemployment forecast to peak at above 10 percent in the second half of 2010, there should be considerable slack in the economy, the IMF said. It expects core inflation, which excludes volatile food and energy costs, to remain below 1 percent through most of next year.

In the medium term, the IMF said the potential growth rate for the U.S. economy was likely to be below 2 percent for a considerable time. That was a gloomier assessment than the Fed's, which has pegged longer-run potential growth in the 2.5 percent to 2.7 percent range.

Analysis of previous financial crises suggests that many are followed by large, permanent output losses relative to pre-crisis trends, because impaired financial systems take time to heal and to again intermediate effectively, slowing investment and innovation, the IMF said.

DEBT OVERHANG

In Canada, a key U.S. trading partner, the WEO forecasts 2.1 percent economic growth next year, well below the Bank of Canada's latest projection of 3 percent growth.

The central bank said this month the recovery now appears to be sharper than it had anticipated, suggesting it may raise its 2010 growth forecast even further in a report due October 22.

The IMF said U.S. President Barack Obama's proposals to overhaul financial regulation were sensible.

The key will be to implement the measures as a comprehensive package, rather than in piecemeal fashion, and to tackle the problem of having firms that are too big or connected to fail, the Fund said.

Healthcare reform will also be critical. The IMF criticized significant inefficiencies in the U.S. system, and said efforts to extend coverage to the uninsured should be done in a budget-neutral manner. The United States will need to curb the rate of cost increases to maintain debt sustainability.

It warned that the financial crisis had contributed to a high and rising debt trajectory that could become unsustainable without significant medium-term measures.

The IMF estimated that U.S. debt would reach almost 110 percent of gross domestic product by 2014, a worrisome deterioration given looming healthcare and pension pressures related to population aging. (Additional reporting by Louise Egan in Ottawa; Editing by Andrea Ricci)

International Monetary Fund