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European consumer prices fell by the most in at least 13 years in July after energy costs declined and unemployment rose to the highest in a decade.

Prices in the euro region dropped 0.6 percent from a year earlier, the most since the data were first compiled in 1996, the European Union statistics office in Luxembourg said today. That exceeded the 0.4 percent decrease forecast by economists, according to the median of 32 estimates in a Bloomberg survey. Unemployment rose to 9.4 percent in June, the highest since 1999, a separate report showed.

More than 3 million people have joined the euro region’s jobless rolls in the last year, and the Organization for Economic Cooperation and Development expects the unemployment rate to reach 12 percent in 2010. As consumers and companies reduce spending to weather the worst recession in more than 60 years, inflation is also being pushed lower by a 50 percent drop in the price of crude oil over the last year.

“The larger-than-expected drop in inflation and the unrelenting rise in unemployment should serve as a stark reminder to the ECB that medium-term inflation risks in the euro zone are tilted to the downside,” said Martin van Vliet, senior economist at ING Bank in Amsterdam.

The European Central Bank aims for inflation to be just under 2 percent and ECB President Jean-Claude Trichet has said he expects inflation to “temporarily remain negative” before turning positive by year end. While the central bank says mid- to long-term price expectations are “anchored,” a European Commission measure of those expectations fell in July to the lowest since at least 1990, a report showed yesterday.

‘Deflationary Environment’

“The risks on the deflation side are there,” said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc in London, which estimates euro-area inflation is the lowest since 1953. “The underlying dynamics do resemble those that you would see in a typical deflationary environment.”

The euro was little changed against the dollar after the data and traded at $1.4108 at 10:43 a.m. in London, up 0.2 percent on the day. The Dow Jones Stoxx 600 Index of European companies rose less than 0.1 percent to 225.31.

The ECB has cut its benchmark interest rate to a record low of 1 percent and started buying as much as 60 billion euros ($84 cash advance.6 billion) of covered bonds to stimulate lending.

The International Monetary Fund said in a report yesterday that the ECB should maintain its “accommodative” stance “as long as disinflationary pressures persist.” The ECB key rate’s 1 percent level should not be considered a “floor,” said Marek Belka, head of the Washington-based IMF’s European department.

‘This Possibility’

“We do not see deflation as imminent,” Belka said. “But we shouldn’t completely exclude this possibility.”

German consumer prices fell in July from a year earlier for the first time in 22 years, data showed this week. Spain and Ireland have experienced annual price declines since March as Tesco Plc and Marks & Spencer Group Plc have reduced prices in their Irish stores.

Lower oil prices contributed to a 54 percent drop in second-quarter earnings at Total SA, Europe’s third-largest oil producer, the Paris-based company said today. Laurent-Perrier SA, the maker of Grand Siecle champagne, may see profitability decline as consumers switch to cheaper vintages, Chief Executive Officer Stephane Tsassis said in an interview.

Metro AG, Germany’s largest retailer, said on July 17 that it plans to charge less on 5,000 items at its Cash & Carry unit, and said the same day that it would cut 1,340 jobs.

Jobless Rate

Unemployment in the euro region increased by 3.17 million people in the year through June and the highest jobless rate was in Spain, at 18.1 percent, according to today’s report. Most Europeans think the worst of the crisis is still to come and a third of workers are “very concerned” about losing their jobs, a survey published on July 24 by the European Commission showed.

The inflation report released today is an estimate. The statistics office will publish a detailed breakdown of the consumer-price data, including energy-price inflation as well as the core rate, on Aug. 14.

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U.K. house prices increased for a third month in July as a shortage of supply helped shield the property market from the economic slump, Nationwide Building Society said.

The average cost of a home climbed 1.3 percent to 158,871 pounds ($260,000) after rising 1 percent in June, the mortgage lender said in a statement today. Economists predicted a 0.2 percent increase, according to the median of 14 forecasts in a Bloomberg News survey. From a year earlier, prices fell 6.2 percent, the smallest annual drop since May 2008.

The report adds to signs that the U.K. housing market may be starting to recover as the economy emerges from the worst recession in at least three decades. The Bank of England will decide next week whether to continue its program of buying bonds with newly created money.

“House prices have been remarkably resilient this year, despite a recessionary economic background with sharply rising unemployment,” said Martin Gahbauer, chief economist at Nationwide. “It is unlikely that price increases can be sustained for long at the very strong rate observed over the past few months. One of the factors helping prices to stabilize in 2009 is the shortage of properties available for sale.”

The pound rose and gilts fell after the report business cards. The pound gained 0.6 percent against the dollar to $1.6468 as of 8:50 a.m. in London. The yield on the 10-year government bond increased 2 basis points to 3.98 percent. Yields move inversely to prices.

Supply Shortage

House prices rose 2.6 percent in the three months through July, the most since February 2007, compared with 1 percent growth in the period through June, Nationwide said.

Former Bank of England policy maker Stephen Nickell said today that Britain needs to build 3 percent more homes than he estimated last year because the recession has hit homebuilding.

U.K. mortgage approvals rose to a 14-month high in June, the central bank said yesterday. House prices rose 1.3 percent in the first seven months of 2009, suggesting values may rise “slightly” in 2009 after falling about 16 percent last year, Nationwide said.

The Bank of England kept its key interest rate at a record low of 0.5 percent this month and voted for no change in the asset-purchase arrangements. Policy makers make their next decision on the benchmark rate and so-called quantitative easing on Aug. 6.

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U.S. and Chinese economic leaders pledged to keep up stimulus efforts and to rein in trade and investment imbalances that contributed to the global crisis.

“It is vitally important for China and the United States to see through their commitments to repair the financial system and lay the foundation for recovery,” Treasury Secretary Timothy Geithner said at the end of the first Strategic and Economic Dialogue talks under the Obama administration in Washington. China’s Vice Premier Wang Qishan said the two will press for an “expansion” of the recovery.

The U.S. pledged to curb the budget deficit and boost household savings, and China committed to rely less on overseas demand for its goods. There were few signs of the disputes over the yuan and market access that characterized talks in the Bush administration. Analysts expressed skepticism whether the two governments can secure “balanced” growth.

“These statements are made in good faith, but the issue is that you can’t just wave a magic wand and get there overnight,” said Huw McKay, senior international economist at Westpac Banking Corp. in Sydney. “These things take long periods of time.”

The two sides indicated that while economic data improved in recent months, a self-sustaining rebound has yet to emerge. In the U.S., President Barack Obama is implementing a $787 billion fiscal stimulus and Federal Reserve Chairman Ben S. Bernanke doubled the central bank’s balance sheet to about $2 trillion. China has a 4 trillion yuan ($585 billion) stimulus.

‘Strong’ Responses

“Both countries pledged to maintain their strong policy responses until recovery is secured,” the U.S. Treasury said in a statement.

Zhou Xiaochuan, the Chinese central bank governor, said China will wait for the U.S. to begin to pull back on its stimulus measures before deciding whether it will do the same.

“If we see that the U.S. starts to exit its expansionary fiscal and monetary policies, then China will see what it will do at that time,” Zhou said at a press briefing today.

The People’s Bank of China governor also said that “I believe that the Federal Reserve of the U.S. will make appropriate arrangements to prevent high inflation.”

The U.S. Treasury highlighted China’s commitments to liberalize business and investment rules, including letting international banks underwrite Chinese bonds, raising the threshold for foreign direct investments that need government approval, and loosening limits on interest rates.

‘Sustainable’ Deficit

China’s officials reiterated their concern at the record American budget deficit, and were told by Obama’s aides that there’s a plan to achieve a “sustainable” deficit by 2013. Their comments today indicated they accepted the U.S. presentation.

“Credible steps will be taken by the U.S. to control the deficit,” China’s Finance Minister Xie Xuren said at a press briefing today. “The Treasury secretary stated clearly that they are placing a lot of importance on this issue.”

At stake is sustaining demand for U advance payday loans.S. debt from China, the largest foreign holder of Treasuries. The federal deficit is on course to reach $1.8 trillion this year; China’s investments in Treasuries reached $801.5 billion in May, about 100 percent more than at the start of 2007.

“We are joined at the hip with China and that means both countries need to be sensitive to each other’s needs, each other’s problems,” Mickey Kantor, a former U.S. Trade Representative, said in an interview from Los Angeles.

Yuan Policy

China’s Treasuries holdings also are the result of holding down the value of the yuan, a policy that U.S. lawmakers have charged is designed to provide a subsidy for its exports. The yuan has hovered around 6.83 per dollar since July last year after gaining about 21 percent since China lifted a strict peg to the dollar in July 2005.

Zhang Xiaoqiang, vice chairman of the National Development and Reform Commission, told reporters yesterday that “compared with previous meetings” between Chinese and U.S. officials, “the U.S. side doesn’t lay as much emphasis on renminbi exchange-rate reform and opening of capital markets.” The yuan is a denomination of the renminbi.

The effort to produce more “balanced” growth comes after Bernanke and other officials blamed imbalances in trade, spending and investment for helping spark the crisis.

Trade, Investment

U.S. consumers relied on borrowing to finance their purchases, contributing to an export boom from Asia. As China and other Asian nations accumulated dollars from trade surpluses, they bought bonds and depressed global yields. Lower borrowing costs helped stoke the housing and credit booms that turned to bust in 2007.

China and the U.S. will aim to “bring about more balanced and sustainable global economic growth after a global recovery is firmly established,” the two sides said in a fact sheet on the economic side of the talks.

“Building a consumption-based economy is overdone and overhyped” with regard to China, Donald Straszheim, who heads Straszheim Global Advisors Inc. in Los Angeles. “It will take a generation, not just a few years, for China’s consumer sector to really develop.”

In the U.S., officials will take steps to reduce its current-account deficit, boost private savings and cut its budget deficit once a recovery is “firmly established,” Geithner said.

The U.S. savings rate reached 6.9 percent in May, the highest level since 1993, as Americans consumers curtailed spending. Geithner said he expects those gains to be part of a more permanent shift.

“We’re more likely to decide that these changes we’ve seen in private savings already are durable,” Geithner said. “We’ve learned some tough lessons as a country. I think the basic lesson, the importance of living within our means, is best for the country, and at the household level, is an important, necessary lesson.”

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The worst U.S. recession in five decades probably eased in the second quarter as trade and government stimulus mitigated the damage from declines in housing, inventories and consumer and business spending, economists said before a report this week.

The world’s largest economy shrank at a 1.5 percent pace following a 5.5 percent drop in the first three months of 2009, according to the median forecast of 66 economists surveyed by Bloomberg News ahead of Commerce Department figures due July 31. Other reports may show orders for long-lasting goods fell and sales of new houses rose.

Leaner stockpiles set the stage for a return to growth this quarter as manufacturing and homebuilding stabilize, while efforts to revive demand globally boost exports. Consumer spending, which accounts for 70 percent of the economy, may be slower to recover as unemployment is projected to keep rising and home values are likely to fall further.

“The recession has decelerated sharply and is starting to form a bottom,’ said Joel Naroff, chief economist at Naroff Economic Advisors Inc. in Holland, Pennsylvania. “I think we’ll see some growth in the third quarter.” Naroff was the top forecaster in 2008, according to a survey by Bloomberg Markets magazine.

A drop last quarter would be the fourth consecutive decrease in GDP, the longest losing streak since quarterly records began in 1947. The decline so far has been the deepest since 1957-58.

GDP Revisions

The Commerce report will also include GDP revisions that may affect figures going back to when the government started keeping annual records in 1929.

Stocks rallied last week and bond prices fell on signs the economy was bottoming. The Dow Jones Industrial Average broke above 9,000 for the first time since January, gaining 4 percent over the five days to end the week at 9,093.24. Ten-year Treasury notes posted a second weekly loss, yielding 3.66 percent late on July 24.

Orders for durable goods last month fell 0.6 percent, economists project another report from Commerce on July 29 will show. Bookings rose in the prior two months. Excluding demand for transportation equipment, which is often volatile, orders were forecast to be little changed.

Machinery exporters are among those seeing signs of improvement. Caterpillar Inc., the biggest maker of earthmoving equipment, posted second-quarter profit that exceeded analysts’ highest estimate and raised its full-year forecast, saying stimulus programs are starting to support global demand cheap payday loans.

Stimulus Working

“We are seeing signs of stabilization that we hope will set the foundation for an eventual recovery,” Chief Executive Officer Jim Owens said in a statement July 21. “Credit markets have improved significantly. Fiscal policy and monetary stimulus have been introduced around the world, and we are seeing signs, particularly in China, that they are beginning to work.”

The economy will grow at an average 1.5 percent rate in the last six months of the year, according to economists surveyed by Bloomberg in the first week of July. Unemployment, which reached a quarter-century high of 9.5 percent in June, will top 10 percent by the first three months of 2010, the survey showed.

The projections are in line with estimates by Federal Reserve policy makers.

“The pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization,” Fed Chairman Ben S. Bernanke told Congress last week. “The labor market, however, has continued to weaken.”

Housing, Manufacturing

Both manufacturing and housing are showing signs of forming a bottom. Existing home sales have risen for three months, while the Institute for Supply Management’s gauge of factory activity has shown a lessening pace of contraction since January.

New-homes sales probably rose 2.9 percent in June, to a 352,000 annual rate, economists surveyed projected a Commerce report on July 27 will show. Purchases reached a record low in January.

Home prices continue to fall, albeit at a slower pace. The S&P/Case Shiller index of 20 major metropolitan areas, due July 28, will probably show property values fell 17.9 percent in May from a year earlier, according to the median forecast. The measure was down 18.1 percent in the 12 months ended April.

Dropping real-estate prices and rising joblessness have tattered household finances. A survey from the New York-based Conference Board on July 28 may show consumer confidence fell in July for a second month, the survey showed.

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Bank of England policy maker Andrew Sentance said the bank’s economists anticipate data today to show a “small” drop in U.K. second-quarter gross domestic product as the recession nears its end.

The contraction will be “much less than we saw in the first quarter” and will precede “evidence of positive growth in the second half of the year,” Sentance said in an interview yesterday in London.

GDP figures due at 9:30 a.m. in London will probably show a 0.3 percent decline from the first three months of 2009, the least in a year, the median forecast of 32 economists in a Bloomberg News survey shows. Former policy maker David Blanchflower told Bloomberg Television the drop may be as big as 0.4 percent and may be revised to show a bigger contraction.

The pound rose and the yield on the U.K. 10-year gilt climbed above 4 percent for the first time since June 12 after Sentance said that the bank will consider pausing bond purchases if forecasts justify it. Barclays Capital and Credit Suisse AG predict that policy makers will suspend the 125 billion-pound ($206 billion) asset-purchase program at the Aug. 6 decision.

Bank of England Deputy Governor Charles Bean said this week that the economy, which contracted 2.4 percent in the first quarter, may now have stopped shrinking.

Sentance said yesterday that policy makers may shift the bond-buying plan to a “watching” stance if new quarterly growth and inflation forecasts published next month show a recovery may be in train.

August Options

“Even if we decided not to do any more in August, there’s still the option of returning to this policy instrument in the future,” Sentance said in an interview. The question will be “whether we’re now going to move into a phase where we’re watching and observing what happens in the economy life insurance.”

Evidence is mounting that the global economy is recovering from recession. Canada’s central bank said yesterday that the nation’s slump is ending this quarter, while Federal Reserve Chairman Ben S. Bernanke said this week that the worst housing slump eight decades appears to be moderating.

Sentance said it is difficult to predict exactly when the economy will start growing again.

“There are negative drags, in particular problems in the banking sector,” he said.

Blanchflower, in an interview recorded yesterday, said any economic recovery will be “ pretty anemic, pretty slow for a year or two.” He said the bank must keep expanding its asset- purchase program, and should consider spending as much as 300 billion pounds in newly printed money. That’s twice as much as the current total authorized by the government.

‘Early Days’

“It’s very early days to say that you know the endgame is even in sight,” Blanchflower said, speaking from Dartmouth College in Hanover, New Hampshire, where he is professor of economics. “My worry is that the tightening comes too soon and people kill off any recovery that’s coming.”

Withdrawing stimulus prematurely, either by unwinding the bond-purchase program or by raising the key interest rate from the current record low of 0.5 percent, risks pushing unemployment higher, Blanchflower said. The International Labour Organization measure of joblessness may rise by a further 1 million people to reach 3.4 million, he said.

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Global investors give Federal Reserve Chairman Ben S. Bernanke top marks for combating the worst financial crisis since the Great Depression and overwhelmingly favor his reappointment amid optimism that the world economy is on the mend.

Sixty-one percent of investors surveyed in the first Quarterly Bloomberg Global Poll say the world economy is stable or improving and almost 75 percent take a favorable view of the 55-year-old chairman. By almost a three-to-one margin, they say Bernanke has earned another four-year term when his current one expires in January.

“He’s the best, maybe around the world,” said Wallace Lin, an investment manager with Euro Asset Management in Hong Kong, who participated in the poll. Investors ranked Bernanke higher than his counterparts at other major central banks, including European Central Bank President Jean-Claude Trichet.

The vote of confidence strengthens Bernanke’s hand as he faces congressional criticism that the Fed overstepped its authority by helping to rescue failing financial institutions in the midst of the crisis. It also gives his bid for another term a boost. President Barack Obama has praised Bernanke’s performance atop the central bank without saying whether he wants him to stay.

Market Repercussions

“If he weren’t renominated, it could have potentially very serious and severe repercussions on the stock market and the economy,” said Jack Liebau, a poll participant and president of Pasadena, California-based Liebau Asset Management Co.

Investors consider recession a bigger threat to the U.S. economy than rising prices over the next two years, the poll showed. Sixty-one percent cite recession as the greater risk, compared with 37 percent who name inflation.

Martin Feldstein, a professor of economics at Harvard University who was considered for the position of Fed chairman before Bernanke took over in 2006, praised the policy maker. Bernanke has “done a very good job and I think he should be reappointed,” Feldstein said in an interview yesterday on Bloomberg Television.

The first Quarterly Bloomberg Global Poll is a survey of investors and analysts on six continents. It is based on interviews from July 14 to July 17 with a random sample of 1,076 Bloomberg subscribers, who represent leading decision makers in markets, finance and economics.

Trichet, King, Zhou

The poll showed Trichet received a favorable rating of 54 percent, while Bank of England Governor Mervyn King garnered 50 percent approval and China’s central-bank governor, Zhou Xiaochuan, received 42 percent. Bernanke outpolled the other central bank chiefs even in their own regions.

Bernanke also received a higher rating than U.S. Treasury Secretary Timothy Geithner, who formerly ran the New York Federal Reserve Bank. The Treasury secretary got a 57 percent rating worldwide — even though a majority of investors in the U.S. view him unfavorably. More than 52 percent of American respondents take a negative view of Geithner, compared with about 32 percent in Europe and 24 percent in Asia.

Bernanke has countered the credit crisis with actions unprecedented in the central bank’s 95-year history. He cut the benchmark lending rate to as low as zero and expanded credit to the economy by $1.1 trillion over the past year.

U.S. Banks Recovering

More than three-quarters of investors expect U fast cash.S. financial institutions will be in better shape a year from now, though only 2 percent say they will be back to full health. Just 10 percent think they will be in worse shape.

Respondents aren’t as sanguine about European banks, with 23 percent saying their condition will deteriorate in the next year.

Investors in Asia are more optimistic than those in the U.S. and Europe about the outlook for the global economy, the poll showed. More than three-quarters of Asian investors say the world economy is stable or improving, compared with 62 percent in Europe and 50 percent in the U.S.

Regional differences in the global outlook “may be a matter of what they see around them,” said J. Ann Selzer, president of Selzer & Co. of Des Moines, Iowa, which conducted the poll for Bloomberg. Half of Asian investors “say the economy in their region is improving — more than three times as many as say that in the U.S.,” she said.

The International Monetary Fund said July 8 that emerging- market economies including China will help pull the world out of the deepest contraction in six decades.

China’s Recovery

China’s gross domestic product grew 7.9 percent in the second quarter, the government reported last week in Beijing, making the nation the first major economy to rebound from the global recession.

“Fiscal policy and monetary stimulus have been introduced around the world, and we are seeing signs, particularly in China, that they are beginning to work,” Jim Owens, chief executive officer of Caterpillar Inc., said in a statement yesterday. Peoria, Illinois-based Caterpillar, the world’s largest maker of construction equipment, reported second-quarter profit that exceeded analysts’ forecasts.

More than half the investors polled expect long-term interest rates to rise over the next six months as global growth picks up. Among equity investors, 52 percent foresee higher yields, compared with 49 percent of fixed-income investors.

Higher Long-Term Rates

“I don’t see them going anywhere but up,” said David Jaderlund, municipal bond portfolio manager with Jaderlund Investments in Albuquerque, New Mexico. Currently, he said, Treasury securities “aren’t paying anything.”

Benchmark 10-year notes yielded 3.48 percent at 5:15 p.m. yesterday in New York, compared with an average 4.56 percent over the last decade.

Investors expect short-term interest rates to be little changed over the next six months, the poll showed. Almost three quarters say central banks will hold rates near current levels to support growth.

“Monetary policy remains focused on fostering economic recovery,” Bernanke said in his semi-annual report to Congress yesterday. The Fed intends to maintain a “highly accommodative” monetary policy for “an extended period,” he said.

“The U.S. economy may be ailing,” said Selzer. “But these financial leaders agree the man at the helm of the economy is the right guy for the job, for now and for another term.”

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California lawmakers reached an agreement with Governor Arnold Schwarzenegger over how to close a $26 billion budget deficit that pushed the most-populous U.S. state to the brink of insolvency.

The deal, reached by legislative leaders after two months of frequently acrimonious negotiations, would slash spending for schools, public works and welfare programs amid the longest recession since the 1930s. If approved by the full Senate and Assembly, the agreement will also siphon money from municipalities, force companies and individuals to pay income taxes sooner and make it more difficult to receive state aid.

“We came to a basic agreement, a budget agreement,” Schwarzenegger told reporters outside his office last evening. “This is a budget that has no tax increases and this is a budget that is cutting spending and it deals with the entire $26 billion deficit.”

The agreement promises to end a battle over the $100 billion budget that forced California to pay some bills with IOUs, pushed debt ratings on $72 billion of bonds closer to non- investment grade and threatened to further batter the state’s economy. It is the second time this year that the government redrew the budget amid job losses that pushed unemployment to 11.5 percent in May and declining incomes that lowered tax collections 15 percent from a year earlier.

Senate and Assembly leaders said they will seek to put the proposals to a vote by July 23. It would require passage of more than a dozen bills by a two-thirds margin. While Democrats control both chambers of the Legislature, they are six votes shy of such a supermajority.

Spending Cuts

The agreement calls for cutting spending by $15 billion, including $6 billion from schools, $3 billion from colleges and $1.2 billion from prisons. Schools will be repaid $11 billion once the state’s economy turns around. It also raises $4 billion by in part accelerating personal and corporate income tax withholdings and increasing income tax withholding schedules by 10 percent.

It also calls for the state to divert more than $2 billion of tax receipts meant for local governments, redevelopment agencies and transportation districts. That money would be repaid with interest. Local governments could sell bonds backed by the promise of repayments. The agreement also shifts $1.5 billion between accounts to save money and moves the last payday for state workers in the current fiscal year into the next.

Restore Funding

“I hope sincerely that once we are past this recession, we will be able to restore some of the funding that was cut,” said Senate President Darrell Steinberg, a Democrat from Sacramento.

A budget deal struck in February nearly faltered in the Legislature, only to pass after a weekend of all-night sessions when enough Republicans agreed to what Schwarzenegger called the largest tax increase in California history. Still, the deficits reappeared as the economy failed to emerge from the now 20-month recession.

The magnitude of the slump made it difficult for Democrats and Republicans to agree on a response car insurance. Schwarzenegger, who bucked his party by supporting February’s increase, and his fellow Republicans ruled out another round of raising taxes. Voters in May defeated a proposal to extend the tax increase and borrow money to shore up the budget, an outcome Schwarzenegger said was a message that politicians needed to scale back government.

Cash Borrowing

“We were able to resolve California’s 26.3 billion dollar budget deficit without raising taxes,” Senate Minority Leader Dennis Hollingsworth, a Republican from San Diego, told reporters. “It solves our cash-flow issues and saves money by reforming key government programs so they operate more efficiently.”

Democrats contested the scope of his proposed cuts, which would have eliminated welfare programs that provide aid to jobless families and health insurance to nearly a million children.

Passage of a budget would also clear the way for Treasurer Bill Lockyer to borrow the billions California needs to pay its bills until the bulk of taxes are collected later in the year.

Without a balanced budget, officials said such a borrowing would be costly, if not impossible, because of the state’s tumbling credit rating and concerns among investors about how they would be repaid. Instead, California began issuing IOUs to businesses and individuals to ensure that it has enough cash to meet key obligations — including interest on its bonds — that are given high priority under the constitution.

The use of IOUs has been done only one other time since the Great Depression and it brought unfavorable attention to the state.

Credit Downgrades

On July 14, Moody’s Investors Service cut California’s bond rating by two steps to Baa1, three ranks above speculative ratings and said the state may face further downgrades. That followed Fitch Ratings, which on July 6 lowered its rating on California debt to BBB, just two ranks above high-yield, high- risk junk.

California bond yields, which move in the opposite direction as price, have jumped compared with top-rated municipal bonds. The difference between a 10-year California bond and a top-rated municipal security reached as much as 1.71 percentage points on July 1, when the California debt yielded 5.21 percent, according to Bloomberg data. The difference has since slipped to 1.57 percent as investors speculated that prices would improve once a budget deal is struck.

California, the world’s eighth-largest economy, was already the lowest-rated U.S. state. Standard & Poor’s gives the state it’s A grade, the sixth-highest of 10 investment levels. The firm reaffirmed that assessment on July 1.

Several banks also exerted pressure on lawmakers to act quickly by refusing to exchange IOUs for cash, threatening to deal a blow to businesses that work for the state. Among the banks were JPMorgan Chase & Co. and Bank of America Corp.

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Home resales in the U.S. probably rose in June and a gauge of the economic outlook improved, signaling the recession may soon be over, economists said before reports this week.

Purchases of previously owned homes climbed to an annual rate of 4.83 million, the highest level since October, according to the median of 57 estimates in a Bloomberg survey before the National Association of Realtors’ report on July 23. Figures tomorrow may show the index of leading indicators climbed for a third consecutive month.

Mounting evidence that housing is stabilizing is bolstering forecasts that government stimulus efforts will gain traction in coming months and lift the economy from the worst slump in five decades. Other reports may show rising joblessness is weighing on Americans’ moods, tempering optimism about any rebound.

“The end of the recession could be pretty close,” said Scott Brown, chief economist at Raymond James & Associates Inc. in St. Petersburg, Florida. “We’re getting near the bottom in housing. It’ll still be a very gradual recovery for the economy, with a labor market that’s very weak.”

Reports last week corroborated that the housing slump, now in its fourth year, is dissipating. Housing starts unexpectedly jumped in June to the highest level since November as construction of single-family dwellings climbed by the most since 2004. Building permits, indicating future construction, rose the most in a year.

Signs of Stability

The National Association of Home Builders/Wells Fargo index of builder confidence increased this month to the highest level since September.

One reason for the projected increase in home resales is that prospective buyers are taking advantage of the plunge in prices caused by the foreclosure crisis. Filings reached a record in the first half of 2009, according to RealtyTrac Inc., an Irvine, California-based seller of default data. More than 1 no fax payday loans.5 million properties got a default or auction notice or were seized by banks in the six months through June.

The New York-based Conference Board’s leading index, which points to the direction of the economy over the next three to six months, rose 0.5 percent last month after a 1.2 percent increase in May, according to the survey median.

The jump in building permits was probably one of the biggest contributors to the predicted gain in the leading index, economists said. Fewer jobless claims and higher stock prices were also likely drivers.

Stocks Rise

Stocks have gained on optimism an economic recovery is at hand. The Standard & Poor’s 500 Index is up 39 percent since reaching a 12-year low on March 9.

A July 24 report may show the Reuters/University of Michigan final index of consumer sentiment fell in July after four consecutive gains, economists predicted. A preliminary reading dropped to the lowest level since March.

The U.S. has lost about 6.5 million jobs since the recession began in December 2007. Economists in a separate survey taken by Bloomberg this month predicted the jobless rate will reach 10 percent by year-end from 9.5 percent in June.

Federal Reserve officials thought the economy was “still quite weak and vulnerable to further adverse shocks,” according to minutes of their June meeting released last week. Even so, the report also said “the economic contraction was slowing and that the decline in activity could cease before long.”

Companies seeing an improvement include CSX Corp., the third-largest U.S. railroad. Jacksonville, Florida-based CSX reported second-quarter profit that topped analysts’ forecasts, and said demand for hauling most freight is stabilizing. Railroad traffic is considered an economic bellwether.

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The debate over whether the $787 billion stimulus package is sufficiently large or efficiently designed obscures a broader question, some economists say: Can any fiscal measure pull the economy out of the recession?

With credit still crimped and the outlook for consumer demand gloomy due to rising unemployment and increased personal saving, no amount of government intervention will be able to stanch the hemorrhaging of jobs and quickly ease the U.S. out of its deepest recession in a half-century, they said.

“Many households that want to borrow can’t, and many that can borrow won’t because they now must save for retirement the old-fashioned way,” said Richard Clarida, global strategic adviser at Newport Beach, California-based Pacific Investment Management Co., the world’s biggest bond-fund manager. “As a result, the multiplier from even a well-designed stimulus package is likely to be quite modest.”

The stimulus plan passed in February “is executing pretty much as expected,” yet it “won’t affect the economy’s primary problems, which are falling values of assets like homes and stocks,” said Doug Holtz-Eakin, who was director of the Congressional Budget Office from 2003 to 2006 and is now president at DHE Consulting LLC in Washington. So far, about $60 billion in spending and $43 billion in tax relief has been dispensed, accounting for 13 percent of the plan’s total.

Bond Yields

The slow pace of recovery has driven bond yields lower as investors continue to seek the safety of U.S. government debt. Ten-year note yields are down 38 basis points, or 0.38 percentage point, since June 10.

The outlook for many companies also is clouded. Second- quarter profit at General Electric Co., the world’s biggest maker of power-generation equipment and services, probably fell by more than 50 percent, according to the average estimate of 13 analysts surveyed by Bloomberg. Most benefits from the stimulus plan won’t arrive until next year, the Fairfield, Connecticut- based company’s chief executive officer, Jeffrey Immelt, told investors May 19.

Proponents of the stimulus said the economic situation and the prospects for recovery would be much bleaker if no fiscal response had been put in place.

“It’s working, it’s demonstrably working,” said Jared Bernstein, chief economic adviser to Vice President Joseph Biden, whose office is overseeing the stimulus rollout.

Even though a second stimulus package is unlikely at this point, those advocating such a measure said it may be needed precisely because the effects of the first have been so modest.

‘Multiplier Effect’

The combination of rising unemployment and thrifty consumers “definitely lowers the multiplier effect” of every stimulus dollar spent, said Dean Baker, a co-director of the Center for Economic and Policy Research in Washington. “That just means you need more stimulus. There’s really no alternative.”

Obama administration officials such as Treasury Secretary Timothy Geithner said the measure needs time to work and are appealing for patience.

“The stimulus program was designed to make a contribution over a two-year period and the biggest impact on investment will come in the second half of this year,” Geithner said yesterday in an Internet chat with Les Echos newspaper in Paris.

Martin Feldstein, a professor of economics at Harvard University in Cambridge, Massachusetts, and former head of the National Bureau of Economic Research, said the stimulus may provide a short-term boost that will quickly ebb.

‘Fade Out’

“We’ll get that bounce for a couple of quarters but then it will fade out,” Feldstein said.

It’s too early to consider another round of fiscal priming, Geithner said. “I don’t think we’re in a position yet to make that judgment.”

For the moment, the initial measure has shown little impact. The net worth of households has fallen almost 22 percent, by almost $14 trillion, since 2007, to the lowest level in five years. House prices have fallen more than 32 percent from their 2006 peak, according to the S&P/Case-Shiller national index, while the Standard & Poor’s index of 500 stocks is 40 percent below its October 2007 level payday loans.

The crisis reminded Americans that home values can fall as well as rise and that bull markets don’t last forever, causing consumers to stash away a much larger portion of their incomes. Government data showed that the household savings rate rose to 6.9 percent in May, from zero in April 2008. The May figure is the highest in almost 16 years.

Personal Savings

Nouriel Roubini, an economist at New York University who is chairman of RGE Monitor, and Richard Berner, co-head of global economics at Morgan Stanley in New York, forecast the rate could rise to 10 percent. Economists Reuven Glick and Kevin Lansing of the Federal Reserve Bank of San Francisco estimated in a May 18 paper that Americans would continue to boost their rate of savings, which could reach 10 percent by 2018. Such a jump would trim three-quarters of a percentage point per year from consumer spending.

“There’s been a fundamental change in people’s behavior,” said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and a former Federal Reserve governor.

Rising joblessness could further damp the ability of consumers, whose spending in recent years has made up more than two-thirds of the economy, to continue to shoulder that burden.

Contractions in industries such as autos, construction and financial services have helped shrink payrolls by 6.5 million since the recession began in 2007, Labor Department figures show. The June jobless rate reached 9.5 percent, the highest since 1983.

Jobless Rate

Federal Reserve officials are anticipating a jobless rate of 9.8 percent to 10.1 percent this year, according to the central bank’s latest economic forecast. In an interview last month, President Barack Obama also said the jobless rate would exceed 10 percent before turning for the better.

In addition, the rolls of the long-term unemployed are growing, with 29 percent of the jobless out of work for more than 26 weeks, the most since records began in 1948. A broader measure of underemployment that includes those who want full- time positions but work part-time has almost doubled over the past two years, to 16.5 percent.

Consumer spending is forecast to rise 1.5 percent in the fourth quarter and 1.7 percent for all of 2010, according to a July Bloomberg survey of more than 50 economists. The average quarterly increase from 1997 through 2007 was 3.5 percent.

‘Consumption Animal’

The U.S. consumer “clearly is not going to be the consumption animal that he was for the last 10 or 20 years,” Joshua Shapiro, chief U.S. economist at MFR Inc. in New York, said in a July 6 interview with Bloomberg radio.

Retailers such as San Francisco-based Gap Inc., operator of the Old Navy and Banana Republic chains, and Abercrombie & Fitch Co., a teen-clothing franchise based in New Albany, Ohio, are feeling the pinch. Both reported June sales declines steeper than analysts estimated.

Airlines including Fort Worth, Texas-based AMR Corp., parent of American Airlines, are suffering as business travel declined. The world’s second-largest carrier’s traffic, measured in miles flown by paying passengers, fell 8.2 percent for the quarter, as American and other airlines discounted fares to fill planes. American filled 81.8 percent of its available seats in the second quarter, down from 82.5 percent a year earlier.

Credit, which consumers often turn to during recessions, remains difficult to obtain for many Americans.

About 50 percent of domestic banks tightened credit standards on prime mortgages in the first months of 2009, up from 45 percent in January, according to a survey of bank loan officers conducted by the Federal Reserve in April.

“Although financial market conditions had improved, credit was still quite tight in many sectors,” the central bank said in minutes of the Federal Open Market Committee’s June 23-24 meeting, released earlier this week.

What this means, Clarida said, is that “you’re not going to get the bang per buck that some of the stimulus proponents hoped for.”

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U.S. Treasury Secretary Timothy Geithner said that authorities will be careful not to blunt measures aimed at pulled the economy out of recession.

Withdrawing stimulus too soon “would weaken our long-term fiscal process and weaken the basic fabric of the economy,” Geithner said in an interview with Bloomberg Television in Paris today. “That’s not something we can afford to do.”

The U.S. unemployment rate rose in June to the highest in almost 26 years as officials battle the deepest recession in half a century. Geithner said July 11 it’s too soon to determine whether a second stimulus package is needed, saying that the $787 billion measure that President Barack Obama signed into law in February may not take full effect until the second half.

“We’re not going to repeat the classic mistake that the U health insurance.S. made in the 1930s and that governments around the world have made in financial crises, by at the first sign of hope putting the brakes on prematurely,” he said.

China became the first major economy to rebound from global recession after today reporting 7.9 percent growth in the second quarter. Geithner said that emerging Asian economies are providing ground for “cautious optimism” about the prospects for global growth.

“We’re seeing durable signs of greater confidence” in markets, Geithner said. He earlier called for “comprehensive” reform of compensation practices as part of the U.S.’s shakeup of how financial markets are regulated.

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