The International Energy Agency on Monday cut sharply its medium-term forecast for oil demand because of economic recession, but said the threat of a supply crunch had only receded, not gone away.

Demand will expand by 0.6 percent, or 540,000 barrels per day (bpd) on average, between 2008 and 2014, the adviser to 28 developed countries said in a report. Its previous forecast, issued in December, predicted annual growth of 1 million bpd.

The IEA said demand could prove even weaker depending on the pace of the world's recovery from the recession. The agency also cut its supply forecasts, but pulled back from earlier predictions of a looming supply crunch.

The deep economic recession that has spread worldwide in the past year has taken a severe toll on oil demand, the IEA said in its Medium Term Oil Market Report.

This scenario paints a delayed picture of threatened 'supply crunch' later in the projection period.

The IEA said its working scenario was based on higher Gross Domestic Product figures taken from the International Monetary Fund's 2009 World Economic Outlook, which saw growth recovering to nearly 5 percent annually for 2012-14.

Demand is now expected to rise from 85.8 million bpd to 89 million bpd in 2014.

A lower scenario assumed any rebound in the economy would be slower at around 3 percent annually by 2012, which the IEA said many considered the more likely outcome.

Under the lower scenario, the IEA forecast world oil demand could contract by 140,000 bpd a year in the medium term.

Oil has recovered to roughly $70 a barrel from a low of $32.40 in December and showed little reaction to the latest report from the IEA, which has already taken a more bearish view on demand than other forecasters.

LOWER SUPPLY

Although demand has fallen, investment in new supplies has also shrunk. The IEA has repeatedly warned of a shortfall in energy supplies that could damage any economic recovery.

Its medium-term report in 2007 said there was a risk of a supply crunch by 2012.

In line with previous comment, it said around 2 million bpd of new capacity could have been deferred indefinitely since late last year and a further 4 million bpd faced delays of 18 months or more.

Whether we end up facing a supply crunch again by mid-decade, or with a more comfortable buffer of supply flexibility, depends largely on the pace of economic recovery and government action on efficiency, said Nobuo Tanaka, the IEA's executive director.

The biggest impact of lower spending has been on non-OPEC supply, which the IEA now expected to decline by 0.4 million bpd between 2008-14 compared with its previous prediction of 1.5 million bpd growth.

Total capacity growth was now 4.2 million bpd compared with 5.5 million bpd in its last outlook, the IEA said, while the margin of spare capacity was expected to shrink to only 3-4 percent by 2013-14.

The IEA is careful not to predict oil prices, but said it was assuming nominal prices of $51 for this year, rising to $58.9 a barrel next year.

(Additional reporting by Barbara Lewis/Alex Lawler in London, Editing by Peter Blackburn)

Energy