Federal Reserve officials have pared their outlook for economic growth through 2009 to minimal levels and are prepared to cut interest rates further, while concern has risen that a deflationary spiral may take hold.
The central bank expects growth in the United States to contract in the H2 of 2008 and the H1 of 2009, with some even were more pessimistic, according to minutes released on Wednesday of the Fed’s October 28-29 meeting, when it cut its benchmark interest rate by a half percentage point to a percent.
“Even after today’s 50 basis-point action, the committee judged that downside risks to growth would remain,” the Fed said in the minutes. “Members anticipated that economic data over the upcoming inter-meeting period would show significant weakness in economic activity, and some suggested that additional policy easing could well be appropriate at future meetings,” the US central bank said in the minutes.
US stocks plunged to their lowest closing level in five and a half years on Wednesday as investors braced for a lengthy downturn, including the possibility that US automakers could collapse. David Coard, head of fixed-income sales and trading with the Williams Capital Group in New York, said the Fed’s comments painted a particularly glum picture. “They left no question that they see the economy contracting and that means we are in a recession,” he said.
In a sign of stresses around the world, officials at the Bank of England said they had considered slashing rates by a full 2 percentage points this month before settling for the smaller but still astonishing cut of 1.5 percentage points, according to minutes of its November 5-6 meeting released on Wednesday. The Fed lowered its forecast range for 2008 gross domestic product growth to between zero and 0.3% from its June projection of 1.0 to 1.6%. The economy could shrink by 0.2% in 2009, according to the lower range of the Fed’s central tendencies forecast.
The Fed cut rates to 1% from 1.5% at its scheduled October meeting, after a surprise half-point cut on October 8 in coordination with major central banks around the world in an effort to stabilize financial markets. It has taken the benchmark federal funds rate down 3.25 percentage points in six steps since the beginning of the year.
With expectations of growth ebbing, officials at the US central bank pushed their unemployment projections sharply higher to between 6.3 and 6.5% for 2008 and between 7.1 and 7.6% next year. Some on the Fed think the economy could shrink by 1% in 2009 and that unemployment could go as high as 8%, which would be the highest rate since 1984. The jobless rate hit 6.5% in October. “While some expected an improving financial situation to contribute to a recovery in growth by mid-2009, others judged that the period of economic weakness could persist for some time,” the Fed said.
The minutes showed Fed officials with a new worry: the possibility of a deflationary spiral that they lack power to counteract because interest rates are already so low. “If resource utilization remained weak for some time, inflation could fall below levels consistent with the Federal Reserve’s dual mandate for promoting price stability and maximum employment,” the minutes said. Such a development “would pose important policy challenges in light of the already-low level of the committee’s federal funds rate target,” the Fed said.
Deflation is considered a threat to the economy because a pattern of falling prices causes consumers and businesses to put off purchases in expectations of even lower prices, dragging the economy down further. In a development fuelling fears of deflation, consumer prices fell by 1% in October, the steepest drop since the government began monthly records in 1947.
Fed Vice Chairman Donald Kohn, speaking in Washington on Wednesday, said risks of a deflationary spiral are small, but have risen and must be taken seriously. “Were we to see this possibility, that we should be very aggressive with our monetary policy, as aggressive as we can be,” he said.
The Fed’s next scheduled interest-rate setting meeting is December 16. Markets fully expect a half-point rate cut at that meeting, as indicated by short-term interest-rate futures. (Reuters)