By Howard Schneider, Washington Post

The Obama administration is overestimating U.S. economic growth and needs to reduce its budget deficit far more aggressively, the International Monetary Fund said on Thursday in a report that targeted Social Security, the home mortgage interest deduction and other politically sensitive policies as ripe for cutting.

And in its first-ever analysis of the U.S. financial sector, the agency warned that the recovery and seeming health of the banking industry may be illusory, threatened by an expected wave of defaults on commercial real estate loans and possibly in need of another large injection of capital. Small- and medium-size firms, clustered on the West Coast and in the South, are at particular risk from what may be a trillion dollars worth of bad loans for offices and other commercial buildings, IMF officials said in a briefing.

Though the economic recovery in the United States “has become increasingly well established . . . the risks are tilted to the downside,” said David Robinson, deputy director of the IMF’s Western Hemisphere department. Recent data “have increased those downside risks.”

The assessment is in line with growing concern among members of the U.S. Federal Reserve and elsewhere that the U.S. recovery is losing steam. The IMF said recent data — whether the slow advance of hiring, a laggard home market, or a weak stock market — are not enough in themselves to downgrade its forecasts for U.S. growth, which it predicts will be 3.3 percent this year and 2.9 percent next year.

But it also notes that those forecasts are lower than those used in the Obama administration’s plan to cut the U.S. budget deficit in half by 2013 and stabilize overall U.S. debt by 2015.

Those targets “are welcome,” the IMF said, but would require the United States to find roughly $350 billion in additional budget cuts or tax increases. The fund cited Social Security as the entitlement program that would be easiest to trim — the agency has advocated an increased retirement age throughout the developed world — but also said the United States should consider broad changes in the mortgage interest deduction and other programs meant to encourage home ownership.

Ending the deduction would raise money for the federal government while reforming a system that the IMF says is “costly, inefficient and complex” and of benefit mostly to the better-off.

The reports were released the day after the IMF outlined the risks to the global economy in a pair of reports that focused on the recent turbulence in Europe. The reports said Europe’s weakened economy is now the central threat to global recovery, as its countries struggle with heavy debt, banks face a reckoning over their lack of capital and growth is slowing.

While the fund estimated that growth in the United States and emerging Asian and Latin American countries remains on track, it scaled back projections for Europe and outlined a series of issues there that could — unless controlled — spark problems rivaling those that caused the 2008 collapse of Lehman Brothers.

“Downside risks have risen sharply” in recent months, the IMF said in the report, its first assessment of the world economy since a crisis over government borrowing in Greece. “The ultimate effect could be substantially lower global demand.”

In updating its World Economic Outlook, the IMF slightly raised its overall forecast for global growth, to 4.6 percent for the year, compared with 4.2 percent in its April report. The improvement was based on a stronger than expected performance in the first months of the year, particularly in Asia.

But the outlook for Europe was reduced, as the combined impact of government spending cuts, continued concern over national debt and uncertainty about the banking sector undermines an economy already lagging behind the rest of the world. The IMF projected that the 16 countries that share the euro as a currency will grow just 1 percent this year and 1.3 percent in 2011.

Reflecting the ongoing concern, the European Central Bank on Thursday announced that it would leave its benchmark interest rate at a record low of 1 percent for the 14th consecutive month.

The Bank of England left its base interest rate at a record low of 0.5 percent for the 17th straight month and left its asset purchasing program on hold, the Associated Press reported Thursday. Britain’s economic recovery remains fragile, and analysts say public spending cuts are expected.

The IMF report on Europe, and an accompanying analysis of world economic stability, emphasized how a problem that was considered limited in scope when it surfaced in Greece last fall eventually expanded to other European countries and is now one of the main issues facing the global economy. Governments across Europe are cutting spending and overhauling social programs in an effort to curb record levels of debt, and the Obama administration is studying similar U.S. measures.

Although no other country has reached the crisis point hit by Greece — where borrowing costs skyrocketed until a joint European Union-IMF bailout provided emergency funding — the IMF noted that European countries and the United States will be competing this year to refinance some $4 trillion in government bonds maturing in the second half of the year. With the United States and nations such as Germany considered classic havens, there has been pressure felt in Britain, and in weaker euro-zone economies such as Portugal and Spain, to make a convincing effort to control deficits to keep the favor of bond investors and analysts.

While Europe, in conjunction with the IMF, established a fund to guarantee the repayment of euro-zone government debt, the IMF said that the calming effect of that program is “wearing off.” The interest rates paid by countries such as Spain and Italy — and even some, such as Belgium, considered at the heart of “core Europe” — have been rising again in comparison to those paid by Germany, the continent’s top economic performer.

“On the heels of Greece’s fiscal troubles, investors are now re-pricing these risks across the region,” the IMF said.

In addition, European and other economic analysts are awaiting the result of financial stress tests that will give a sense of how European banks fared during the recent financial crisis and recession, whether they could withstand another downturn and how much capital they might need to raise to be considered healthy.

Stress tests in the United States helped restore confidence in the banking system. But IMF and other analysts say that European banks have been slow to write off bad loans and raise new capital and, until now, have been protected by national governments from a full accounting of their problems.

The issues of government debt and the health of the banks are related: European banks own tens of billions of dollars in Greek, Spanish and other government bonds, and the stress tests will assess how those holdings affect each company’s overall financial health.

The European banking system is plagued by a “legacy of unfinished cleansing,” the IMF said, which has left “pockets of vulnerability, overcapacity, and poor profitability.” Banks have become hesitant to lend to each other — much like what happened during the U.S. financial crisis — and are relying on an unhealthy mix of short-term loans from the European Central Bank to ensure that they have enough cash.

“Recent global stability gains are threatened by a confluence of sovereign and banking risks in the euro area that, without continued and concerted attention, could spill over,” the IMF said.