PARIS - The economic outlook has improved for the first time in two years but soaring unemployment and ballooning budget deficits could knock a weak recovery off track, the OECD said on Wednesday.

The Organization for Economic Cooperation and Development said in its latest economic outlook that the slowdown in its 30 member countries was close to the bottom. Anemic growth of 0.7 percent should return to the area next year after a 4.1 percent fall this year.

That was a slight improvement from its previous forecast for a contraction of 0.1 percent in 2010 following a 4.3 percent fall this year.

This is the first time since 2007 that we have revised up the projection, OECD chief economist Jorgen Elmeskov told Reuters.

The bad news is that the projection still implies that we are only nearing the bottom now and the recovery that follows is going to be a very slow one, probably a fragile one.

World trade will gradually stabilize and then slowly pick up from around the end of this year, the OECD said.

The OECD praised U.S. stimulus policies, saying they paved the way for a recovery in the second half of 2009.

Japan is also showing signs that the contraction is near the end but the recovery is likely to be slow and the economic slack will likely further entrench deflation, the report said.

However, evidence of a pickup in the euro area was harder to pin down because of country-specific issues including housing bubbles, declining exports and problems in the financial sector.

The eventual recovery may also be slow in this region, including because rising unemployment makes consumers more reluctant to spend, the OECD said.

In China, and in other large non-OECD countries, the recovery was expected to be more rapid, the OECD said.

The report said the risks to the outlook were more balanced than before. Its assumption that financial markets would not return to normal before 2010 might prove too conservative.

In terms of the downside, one is that if we do not have convincing plans for fiscal consolidation...the other is the further rise in unemployment will weigh more on household spending than what we have put in, said Elmeskov.

Average unemployment in the OECD area would rise to 9.8 percent next year from 8.5 percent in 2009.

In order to avoid curbing the downturn, it was important to avoid premature withdrawal of fiscal stimulus where there is room, the OECD said.

Countries with relatively low debt, including Germany, Canada, some Nordic countries and Switzerland, have scope for further policy easing in 2010.

But the state of government finances in other countries, such as Japan, Italy, Greece, Iceland and Ireland did not leave any further room for maneuver, without a strong adverse reaction in financial markets.

Failure to send the right signal about withdrawing stimulus could spark inflation fears, lead to further increases in bond yields which could hamper the recovery.

The OECD also urged central banks to keep interest rates close to zero throughout 2009 and 2010 to allow the recovery to take hold, adding that the European Central Bank was not yet at this point. [nLO289793]

Central banks should also keep non-conventional measures in place until the recovery is underway and conditions in financial markets return to normal.

For other stories on the report please click on

(Editing by Toby Chopra)

China Japan Unemployment Inflation