Fed posts gloomy outlook for economy, jobs through 2009

WASHINGTON -- The Federal Reserve on Wednesday dramatically reduced its forecast for economic growth into 2010, predicting significantly higher unemployment and lower inflation, and suggesting more interest rate cuts are likely.

In newly released minutes of its Oct. 28-29 meeting, some Fed officials suggested additional interest rate cuts "could well be appropriate at future meetings" and said rate reductions were justified to ease borrowing costs and forestall the possibility of deflation — a sustained, downward fall in prices.

A quarterly summary of economic projections, released in conjunction with the minutes, paint a downbeat picture. The consensus forecast of the Fed's Board of Governors and 12 regional bank presidents noted the economic outlook had "worsened significantly" since its previous forecast, in June

The Fed officials, who pulled together the projections at a meeting last month, "expected that (economic growth) would remain very weak next year and that the subsequent pace of recovery would be quite slow; they also anticipated that the unemployment rate would increase substantially," according to the report.

The Fed also predicted that "financial market stresses would recede only slowly, notwithstanding the extraordinary measures that had been taken" by the central bank to provide liquidity to banks and other financial firms.

Overall, the Fed's projections anticipate that gross domestic product, the broadest measure of goods and services produced in the USA, will be flat to up a scant 0.3% for all 2008, compared with June projections of 1% to 1.6% growth.

For 2009, the Fed's central forecast is GDP anywhere from a negative 0.2% to positive 1.1% growth, compared with June's prediction for growth in a 2.0% to 2.8% range. The economy is projected to pick up in 2010 to a healthier 2.3% to 3.2% pace.

Economic growth declined at an annual rate of 0.3% from July-August, according to the most recent government report.

The Fed's outlook is similarly bleak when it comes to employment. The Fed now expects the unemployment rate to range from 6.3% to 6.5% in 2008, up from a 5.5% to 5.7% outlook in June.

For 2009, unemployment could range from 7.1% to 7.6%, compared with the previous 5.3% to 5.8% prediction. Fed officials forsee a slow labor market recovery, forecasting that the unemployment rate could remain as high as 7.3% in 2010 and 6.6% in 2011.

The nation's unemployment rate was 6.5% in October.

The slowing economy is expected to push the inflation rate sharply lower. The Fed's central tendency projection is that inflation will range from 2.8% to 3.1% this year, down from the 3.8% to 4.2% projection of June. For 2009, inflation is pegged at a low 1.3% to 2.0%, down from June's 2% to 2.3% range.

The "central tendency" forecasts exclude Fed officials' three highest and three lowest forecasts.

Fed officials generally expect the economy to contract through the end of 2008 and the first half of 2009 and then start to recover, though some "judged that the period of economic weakness could persist for some time."

At its Oct. 28-29 meeting, the Fed cut its target for a key interest rate to a low 1% to combat both a weakening economy and stresses in financial markets. While the vote for that was unanimous, minutes of the meeting highlight the extreme stress, and difficult decisions, the central bank faces.

Some Fed officials said the central bank should move slowly, given that interest rates were already low and rate cuts were not as effective in an environment where credit markets are constrained. Others argued that aggressive action was needed.

The Fed forecast envisions that falling prices could be a problem, with inflation falling below the central bank's informal comfort zone. That led some officials to worry that if the economy remained weak for some time, inflation could "fall below levels consistent with price stability," a development that would pose important policy challanges in light of the already low level of the Fed's rate target.

Fed Chairman Ben Bernanke in the past has said the Fed has a number of policy tools available even if the economy were to face deflation, and it had cut interest rates to zero. But that is certainly not a prospect the Fed relishes.