Fed sharply lowers economic forecast, hints of rate cut
Thursday, November 20, 2008
WASHINGTON -- The Federal Reserve on Wednesday sharply lowered its projections for economic activity this year and next, and signaled that additional interest rate reductions may be needed to help combat the worst financial crisis to jolt the country in more than a half-century.
With the economy forecast to lose traction, or even go into reverse, unemployment will move higher, the Fed predicted.
Facing the likelihood of "significant weakness" in the economy, some Fed officials suggested "additional policy easing could well be appropriate at future meetings," according to documents from the Fed's most recent closed-door deliberations on interest rate policy at the end of October.
At that Oct. 29 session, the Fed ratcheted down rates to 1 percent, a level seen only once before in the last half-century. Many economists predict the Fed will lower rates again at its last meeting of the year Dec. 16, to help brace the sinking economy.
Even while hinting another rate reduction could be forthcoming, Fed officials worried the effectiveness of previous rate cuts "may have been diminished by the financial dislocations, suggesting that further policy action might have limited efficacy in promoting a recovery in economic growth," the documents said.
To help ease financial turmoil and spur banks to lend money more freely again to customers, the Fed has taken a series of other unprecedented steps, including offering short-term cash loans and buying up mounds of short-term debt that companies rely on to pay day-to-day expenses like payrolls and supplies.
Under its new economic forecast, the Fed now believes gross domestic product could be flat or grow by just 0.3 percent this year. GDP could actually shrink by 0.2 percent or expand by 1.1 percent next year. Both sets of projections are lower than the Fed's forecasts delivered to Congress in July.
GDP is the value of value of all goods and services produced within the U.S. and is the best measure of the country's economic health.
The forecasts are based on what the Fed calls its "central tendencies," which exclude the three highest and three lowest forecasts made by Fed officials. The Fed also gives a range of all forecasts that showed some Fed officials projecting a 0.3 percent dip this year, followed by a deeper 1 percent contraction next year.
The economy "would remain very weak next year" and "the subsequent pace of recovery would be quite slow," according to the Fed documents.
The prospects for weaker economic activity will push up unemployment. The Fed projected that the national unemployment rate will rise to between 6.3 percent and 6.5 percent this year. The rate in October was 6.5 percent, and last year the rate averaged 4.6 percent.
Next year, the Fed expects the jobless rate to climb to between 7.1 percent and 7.6 percent -- also higher than its summer forecast.
Inflation, meanwhile, is expected to be lower this year and next compared with the Fed's previous forecast. A global economic slowdown is sapping demand for energy, food and other commodities, driving down prices. That -- along with stronger U.S. dollar -- has reduced inflation risks, the Fed said.
The Fed now expects inflation to be between 2.8 percent and 3.1 percent this year. And, inflation should moderate further to between 1.3 percent and 2 percent next year. Both forecasts are lower than the projections made in the summer.
In minutes of the October meeting, the Fed said "more aggressive easing" in interest rates "should reduce the odds of a deflationary outcome."
Deflation is a prolonged and widespread decline in prices, something the U.S. hasn't seriously suffered through since the 1930s. Once established, it is hard for Fed policymakers to break. That's partly because the Fed can lower its key rate only so far -- to zero -- to combat it.
Earlier Wednesday, the government reported that consumer prices dropped 1 percent in October, the biggest monthly decline on records dating back to 1947. The sharp drop spurred concerns about the possibility -- however remote right now -- of deflation.