WASHINGTON (Bloomberg) — The International Monetary Fund urged US policy-makers to strengthen their response to the housing slump and called on the European Central Bank to lower interest rates as the global economy cools.

The Washington-based lender estimated a 25-percent chance of a world-wide economic downturn in its semi-annual World Economic Outlook, released yesterday. The fund lowered its global growth forecast to 3.7 percent this year from a 4.1 percent prediction in January.

The fund anticipates a "mild recession" in the US, with expansions slowing in Europe and Japan. While central banks have acted "aggressively" to inject cash into the financial system, further efforts may be needed because of the danger of a "full- blown credit crunch," the IMF said.

"The worst is not yet over," said David Bloom, global head of currency strategy at HSBC Holdings Plc in London. "If the IMF predictions prove true, it demands an urgent policy response to galvanise the world economy."

Most IMF executive board members judged that the Federal Reserve may need to lower interest rates further. The US central bank has already reduced its benchmark rate by three percentage points since September, to 2.25 percent.

"The use of public balance sheets may be needed to help financial and housing markets," Simon Johnson, the IMF's chief economist, said at a news conference on the fund's report yesterday in Washington. Fund economists anticipate a 14-percent to 22-percent slide in US house prices.

The Bush administration has opposed using government funds to purchase mortgages or mortgage-backed securities, as proposed by some US lawmakers.

This is the third time the IMF has lowered its projections since July, when it predicted global growth of 5.2 percent this year. IMF economists said the deterioration was due to the "largest financial shock since the Great Depression".

The fund also warned that the new forecasts are more likely to be revised down than up. "The greatest uncertainty comes from the still-unfolding events in financial markets," the report said. Still, "a number" of the fund's executive directors judged that "the staff's new baseline forecast has been marked down too sharply".

Fund economists broke with their tradition of urging fiscal restraint, arguing that countries should consider using tax and spending policies to cushion the slowdown.

"Fiscal policy can play a useful stabilising role in advanced economies in the event of a downturn in economic activity, although it should not jeopardise efforts aimed at consolidating fiscal positions over the medium term," the report said. Stimulus should be "timely, well-targeted and quickly unwound."

Central banks are facing a "delicate balancing act between alleviating the downside risks to growth and guarding against a build-up in inflation," the report said.

The inflation rate in the euro-area is likely to fall back below two percent during 2009 as growth slows. "Accordingly the European Central Bank can afford some easing of the policy stance," the report said.

In Japan, the fund said, rates should remain on hold, "although there would be some limited scope to reduce interest rates from already low levels if there were a substantial deterioration in growth prospects."

The IMF also said that central banks should consider abandoning their resistance to targeting home prices, the "prevailing orthodoxy" among global policy-makers. The US economic slump emerged as a consequence of the worst housing recession in a quarter-century. Rising delinquencies on mortgages also spurred the sell-off in credit markets.

"Recent experience seems to support the case for giving significant weight to house price movements in the context of a 'risk-management' approach to monetary policy-making," the fund said.

IMF directors noted that central banks with inflation targets can still act against asset-price bubbles by "extending the monetary policy horizon". That indicates officials should lengthen the time period for hitting their consumer-price targets.

While emerging markets won't escape the global slowdown, their expansions "will remain robust during both 2008 and 2009," the IMF predicted.

The fund's US forecast was lowered to 0.5 percent for 2008, from 1.5 percent previously. The IMF anticipates a "slow" recovery, with growth of 0.6 percent next year. Johnson said the expansion rate will be "above potential" in 2010. "Many" Fed officials anticipated a contraction in the economy in the first half, according to minutes of the US central bank's meeting last month, released yesterday.

Growth in the euro area is expected to slow to 1.4 percent this year, down from 1.6 percent in the January forecast. Japan will expand 1.4 percent, compared with the 1.5 percent estimate in January.

IMF economists also projected that oil prices will "remain at around $95 a barrel in 2008-09." At the same time, risks for spot prices are "slightly tilted to the downside, likely reflecting downside risks to global growth."