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Amid signs of recovery, caution is still key

By Stella Dawson

WASHINGTON (Reuters) - Call it spring fever. For the third year in a row, optimism is spreading that growth in the United States could be poised to accelerate and drive the economy into sunnier pastures.

Claims for first-time jobless benefits dipped to a four-year low last week as layoffs slow. Factory output is steadily expanding. Retail sales have picked up the past two months. And Europe no longer looms as an immediate threat since Greece restructured its debt and won more bailout money.

Even a 9 percent surge in gasoline prices on tensions with Iran over its nuclear program has failed to take much shine off consumer confidence. The University of Michigan survey slipped by one point to 74.3 in early March, but views on current conditions edged upward.

"For now it's a Goldilocks scenario -- moderate GDP growth, an improving jobs market, only a temporary inflation scare," said Greg Valliere, chief strategist at the Potomac Research Group.

That is a marked improvement from five months ago when the prospect of a Greek sovereign chaotic default loomed large and running battles over the U.S. budget deficit damaged business and consumer confidence. Economists last October put the risk of the United States sliding back into recession at 30 percent.

No one is talking recession these days. The talk now is more about sustainable recovery, and investors are betting the world economy has turned the corner.

Investors poured into stocks last week, shedding safe-haven U.S. and German government debt, and the VIX <.VIX>, an index that tracks U.S. stock market volatility and is know as Wall Street's fear gauge, hit its lowest level since the summer of 2007 when the financial crisis began.

"All things considered, I think we are doing pretty well," former Federal Reserve Chairman Paul Volcker told an economics summit here last week.

FALSE SPRING?

But bursts of optimism have sown false hope before.

This time last year, the U.S. economy was adding jobs at a similar pace of more than 200,000 a month between February and April. Growth was nipped in the bud by the Arab uprising, which sent oil prices soaring, and took another blow when Japan's massive earthquake disrupted the global manufacturing chain. First-quarter output in 2011 was a paltry 0.4 percent and 1.7 percent in the second quarter.

In 2010, prospects had looked even stronger. Between March and May, companies were adding a net 309,000 new jobs each month, and first-quarter growth came in at a 2.7 percent. The rebound proved temporary, largely driven by companies rebuilding inventory after the steepest recession in over 70 years.

Today there is a cautious hope that perhaps this time it's different.

American households have lowered their debt levels and are starting to borrow again. Durable goods are wearing out and demand picking up. Salaries are rising for the highest two income groups, which support 60 percent of all U.S. consumer spending -- itself the biggest driver of the country's economy. Europe's downturn is looking less severe than feared, and while China's outlook remains uncertain and its housing market overheated, officials there could yet pull off a soft landing.

"I am very cautious about the outlook, partly because we got burned last year. But make no mistake, we are getting better numbers here, and there is an upside scenario where we could get a lot of good growth," said Craig Alexander, chief economist at TD Bank Financial Group in Toronto.

The euro zone gets an early look at its factory and service sector for March on Thursday. Economists forecast the flash PMI index will show gradual improvement though they see it remaining a little below the 50 mark, which divides growth from contraction.

STORMS AHEAD

One reason for caution is that many risks still loom. Some are persistent problems left over from the financial crisis that will exert a drag for months to come.

In the housing market, a flood of foreclosures continue to weigh on house prices this year. Housing starts for February, to be released on Tuesday, and new home sales on Friday are seen little changed at 700,000 units and 325,000, respectively. The home builders index also is forecast to hold steady around 30.

Existing home sales, due out on Wednesday, are forecast to rise by 1.1 percent, down from January's strong 4.3 percent showing.

For all its gains, the labor market remains relatively weak. Job growth in this recovery is the slowest since World War Two, and 250,000 to 300,000 new positions would have to be added each month before the 8.3 percent jobless rate would decline substantially. The longer people are out of work, the faster they lose skills, and long-term unemployment is becoming an increasing worry.

While Europe's sovereign debt crisis has abated, it could easily reignite, possibly as soon as this summer. The International Monetary Fund warned on Friday Greece has no room for error. Portugal and Spain are struggling to meet tough budget goals, and European leaders have yet to agree on putting more money into its rescue fund.

Politics also threaten. A military strike against Iran, favored by Israel, would send oil prices sky rocketing and upend growth. In the United States, U.S. fiscal contraction threatens when tax cuts worth about $300 billion-$400 billion expire at year end and budget cuts kick in, creating what analysts call a massive fiscal cliff unless lawmakers decide to delay the measures.

"You have got a 4 to 5 percent hit to GDP and growth already is going to be moderate at best," said Robert Rubin, former Citigroup chairman and U.S. Treasury Secretary in the Clinton administration. "It has enormous, enormous consequences for the economy."

(Editing by Leslie Adler)

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