PARIS (MNI) - The economy of the United States appears to be on the road to recovery, but a return to full health will be slow and there are many risks along the way, The Organization for Economic Cooperation and Development said in its most recent Economic Outlook, published Thursday.

For now, the return to growth is based largely on the hugely stimulative policies of both the U.S. administration and the Federal Reserve, the OECD said. It warned that once those are withdrawn, as they must be, private demand will need to fill the void. And, given the weakness in the labor market, that may not happen so quickly, it said.

"The Federal Reserve and the Administration must begin to withdraw the economic support as economic growth becomes self-sustaining," the OECD said. "Gauging the appropriate timing will not be a simple task, but prolonged stimulus risks unanchoring inflation expectations and destabilising asset markets."

There should be flexibility in exiting from accommodative policies, but the "exit strategies should nonetheless be communicated clearly," it urged.

The OECD's overall outlook for the U.S. economy is significantly more buoyant now than at the time of its previous projections earlier this year. It sharply hiked its GDP growth forecast for next year to a healthy +2.5%, compared with a previous forecast of just +0.9%. For this year, it now sees the economy contracting by 2.5%, slightly less than the previous estimate of -2.8%.

The OECD puts U.S. CPI at -0.4% this year, then up to +1.7% in 2010. It sees the U.S. unemployment rate rising to 9.9% next year from 9.2% in 2009, before heading back down to 9.1% in 2011.

"After the most severe post-war recession, the economy appears to have bottomed out," the OECD declared. "Industrial production has rebounded after a substantial contraction and real GDP grew in the third quarter at a healthy pace."

It cited as significant factors the "cash for clunkers" program, which boosted automobile sales from "severely depressed" levels, and the stock market rally, which has "helped rebuild a fraction of the lost household wealth." The report also noted that housing prices seem to have stabilized.

Still, there are some dark omens, the report said. Non-residential construction is on a downward slope and the labor market has continued to weaken, "though the declines appear to be slowing." Even with the spike in motor vehicle sales, overall consumption expenditures have edged up "only modestly" in recent months, and the economy is left with "significant unused capacity," the OECD said.

It said that "much of the rebound" has resulted directly from the stimulative policies of the Federal Reserve and the Administration. It noted, in particular, the "historically low" Federal Funds rate and the Fed's large-scale purchases of mortgage-backed securities, which has helped drive down mortgage rates and reverse surging spreads on commercial paper and corporate bonds.

It cited a U.S. government estimate that fiscal stimulus programs contributed 2 to 3 percentage points to economic growth after the first quarter of this year and have accounted for "most of the growth that has occurred since then."

But it warned that these stimulus programs carry a high cost: namely, the fact that the U.S. federal government budget deficit is likely to top 10% of GDP this year, up from 2.25% before the recession began.

"There is a risk that the recovery could be compromised by an increase in long-term interest rates resulting from investor concerns about persistently high budget deficits," the OECD warned.

As the government winds down its fiscal stimulus policies in order to address the deficit problem, growth in private domestic demand "should become the main driver of output growth," the report says.

"However, weak fundamentals suggest that the strength of private domestic demand will not be enough for a strong acceleration in output growth in 2010," it warns. "Instead, the current recovery is likely to be modest initially, with a gradual acceleration only in 2011."

Higher housing and stock prices should help promote consumption growth, the report predicts. "However, even with some improvement, the high unemployment rate is likely to depress wage growth and hold down increases in personal income over the next couple of years. As a result, household demand is unlikely to accelerate strongly next year, and, instead, a gradual acceleration appears more likely."