The sharp contraction in the U.S. economy seems to be ending but recovery will be slow with risks still looming from the weak labor and housing markets, the International Monetary Fund said on Friday.

The IMF, in its annual report on the U.S. economy, stuck to earlier forecasts that gross domestic product will shrink by 2.6 percent in 2009 and then rise by 0.8 percent in 2010.

The report was prepared before U.S. data on Friday showed the economy contracted by a 1.0 percent annual rate in the second quarter.

As a result of their increasingly strong and comprehensive policy measures, the sharp fall in economic output seems to be ending, and confidence in financial stability has strengthened, the IMF said in its report, which followed consultations with U.S. officials and institutions.

Nevertheless, with financial strains still elevated, the recovery is likely to be gradual, and risks are tilted to the downside, it said.

The IMF said unwinding fiscal and monetary stimulus measures

would have to wait until a sustainable recovery is underway. But they need to develop exit strategies from stimulus programs, strengthen financial regulation and in the medium term cut budget deficits.

Charles Kramer, head of the IMF's North American Division, said the United States may need more stimulus measures if economic and financial conditions worsen significantly.

Still, he said, policy-makers should be thinking about how to end the generous fiscal and monetary policy measures put in place over the last 10 months.

We should emphasize that now is not the time to implement the exit, but it's a good time to be developing and communicating exit strategies to underpin confidence, Kramer told reporters on a conference call.

The IMF's North American division deputy, Marcello Estevao, said rising unemployment is the greatest threat to recovery efforts.

The weakness in the labor market is going to reflect into the weakness in the housing market. When people lose jobs, wages don't grow as much, it's harder for people to pay their mortgage, Estevao said.

There is substantial uncertainty exactly how this feedback would play out. And that is one of the reasons we have this very gradual recovery outlook for the U.S.

He said the IMF sees U.S. GDP growing a little bit in the second half, with a sustained recovery not starting until the second quarter of 2010.

The IMF's forecast for unemployment was unchanged, seeing 2009 unemployment averaging 9.3 percent and rising to 10.1 percent for 2010.


The IMF directors said the Federal Reserve would need to maintain a diverse set of tools to respond to evolving market conditions, and it recommended that assets it holds from bailed-out financial institutions, known as the Maiden Lane facilities, be transferred to the U.S. Treasury to protect the central bank from credit risk.

The value of assets that the Fed has taken over from American International Group , for example, have been reduced by several billion dollars in recent months.

The IMF welcomed the Obama administration's efforts to revamp the U.S. financial regulatory system, and said this should aim to discourage size and complexity among financial firms to limit potential systemic risks in the system.

The IMF also maintained its view that the U.S. dollar was moderately overvalued, though Kramer noted the dollar has been volatile because of safe-haven flows into U.S. assets during the crisis and the subsequent unwinding of that as the crisis eased.

(Editing by James Dalgleish)