Fed forecasts economic slowdown

updated 4:54 p.m. ET Nov. 20, 2007

WASHINGTON - The housing collapse and credit crisis will slow economic growth and nudge up unemployment next year, the Federal Reserve said Tuesday in a first-of-its-kind forecast that some economists believe will lead to interest rate cuts early in 2008.

Don’t count on a cut in rates at the Fed’s December meeting, however, analysts say. The Fed called its rate reduction in late October a “close call” and hinted that its two cuts this year may be sufficient to energize the economy, according to minutes of the Oct. 31 closed-door meeting made public Tuesday.

Policymakers raised concerns at that meeting that inflation might flare up again in the short term, especially in the face of rising energy prices.

But with the Fed’s longer-term forecast calling for moderating inflation next year and beyond, economists believe the central bank will have leeway to reduce rates next year.

“The economy is walking on a high wire. Eventually the Fed will have to cut rates again to put a net or a cushion under a falling economy,” said Stuart Hoffman, chief economist at PNC Financial Services Group. He and other economists predicted more rates cuts early next year to prevent the possibility of the economy falling into a recession.

On Wall Street, the Dow Jones industrials gained ground after the Fed issued its forecast and minutes of the October meeting. The Dow Jones industrials were up more than 50 points.

The Federal Reserve, in the first of its quarterly economic reports to the nation, said it believes business growth will slow next year, with the gross domestic product gaining between 1.8 percent and 2.5 percent. That would be weaker than how the Fed expects the economy to perform this year and would mark a downgrade to a previous projection released in the summer.

GDP is the value of all goods and services produced within the United States and is the best barometer of the country’s economic fitness.

The downgrade to GDP was due to a number of factors, including “the tightened terms and reduced availability of subprime and jumbo mortgages, weaker-than-expected housing data and rising oil prices,” the Fed explained.

The credit crunch has made it both more costly and more difficult for people and companies to borrow money. The worst carnage has taken place in the market for subprime home loans — those made to people with spotty credit histories. Credit problems started there and have spread to more creditworthy borrowers, including those who are looking for home loans of more than $417,000, so-called jumbo loans.

The big worry is that these housing and credit problems will make people and businesses less inclined to spend, dealing a larger-than-expected blow to national economic growth.

“The possibilities that markets could relapse or that current tighter credit conditions could exert unexpectedly large restraint on household and business spending were viewed as downside risks to economic activity,” the Fed said in its quarterly forecast. “Participants were concerned about the possibility for adverse feedbacks in which economic weakness could lead to further tightening in credit conditions, which could in turn slow the economy further.”

T.J. Marta, fixed income strategist at RBC Capital Markets, said he expects “negative developments in financial markets will tip the Fed toward easing” interest rates by the first quarter of next year.

With economic growth slowing, the unemployment rate would rise to between 4.8 percent and 4.9 percent next year — still low by historical standards. A previous forecast estimated the unemployment rate next year would be about 4.75 percent. For all of last year, the jobless rate dipped to 4.6 percent, a six-year low.

The Fed said the “unemployment rate would increase modestly” in 2008, stabilize in 2009 and then decline slightly in 2010.

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