The United States is heading for only a tepid recovery next year, and the central bank may need to buy even more assets to combat the growing threat of deflation, the OECD said on Tuesday.

In an interim report ahead of this week's Group of 20 summit of rich and emerging countries, the Organization for Economic Cooperation and Development also said Canada had room for a more aggressive crisis response, and the Bank of Canada should consider quantitative easing.

The OECD forecasts showed U.S. real gross domestic product falling 4 percent in 2009 and then flattening in 2010. For Canada, real GDP was forecast to fall 3 percent in 2009, and increase 0.3 percent in 2010.

A gradual recovery may take hold next year as financial conditions improve and macroeconomic policies exert a growing positive impulse, the OECD said about the U.S. economy.

However, it said deflation was a distinct possibility and the U.S. Federal Reserve may need to expand its already swollen balance sheet by buying more longer-term U.S. government and mortgage debt to combat the threat of falling prices.

The Fed should keep interest rates at their current level near zero through 2010, the OECD advised. Many of the lending programs the central bank introduced to counter the credit crisis also need to be maintained through next year.

It said more government spending may be needed in addition to the recently launched $787 billion stimulus package should the economic outlook deteriorate further.

The key to recovery is stabilizing the financial sector, and efforts under way to stress test banks and buy up bad assets should help, the group said. Plans need to be implemented swiftly and the government should stand ready to take more decisive action if necessary.

Policy-makers should make it clear that (they) will not hesitate to restructure systemically important but fragile financial institutions, even if that entails taking control of them, putting them into receivership, removing bad assets, and recapitalizing the remaining 'good bank' with public funds.

In Canada, the OECD said there was room for further fiscal measures, and provinces should step up stimulus spending to complement federal efforts.

The Bank of Canada, which has already lowered its benchmark interest rate to 0.5 percent, should use the limited scope it has left and also consider quantitative easing, the OECD said.

(Reporting by Emily Kaiser, Editing by Chizu Nomiyama)

Canada Inflation Quantitative easing