Fed Officials Lowered Growth Outlook at Last Meeting (Update4)

By Scott Lanman


Jan. 2 (Bloomberg) -- Federal Reserve officials said economic growth in 2008 will fall short of their own forecasts, reflecting weaker consumer spending and a deeper housing slump.

Policy makers ``agreed on the need to remain exceptionally alert to economic and financial developments and their effects on the outlook,'' the Federal Open Market Committee said in minutes of the Dec. 11 session, released today in Washington. ``Members would be prepared to adjust the stance of monetary policy if prospects for economic growth or inflation were to worsen.''

Fed officials anticipated growth that was ``somewhat more sluggish'' than they projected in October, while refraining from signaling a bias to lower rates further, citing ``heightened uncertainty.'' By contrast, traders predict December's quarter point cut in the benchmark interest rate will be followed by reductions at the next two meetings to stave off recession.

``The tone of the Fed minutes suggests more cuts to come,'' said Alan Skrainka, chief market strategist in Des Peres, Missouri, at Edward Jones & Co., which oversees $485 billion. The economy isn't performing as ``they thought it would, and conditions in the credit and housing markets continue to erode since the last meeting.''

Some FOMC members said the chance of further tightening of lending standards may restrain economic expansion and ``require a substantial further easing of policy.'' At the same time, officials judged that a rapid improvement in financial conditions would mean ``a reversal of some of the rate cuts might become appropriate,'' the minutes showed.

Treasury Rally

Treasury notes stayed higher after the report. The yield on the benchmark 10-year note fell to 3.91 percent at 4:13 p.m. in New York, from 4.03 percent late Dec. 31.

The Fed also said that one official opposed last month's agreement to provide dollars to European central banks to help meet banks' funding needs. St. Louis Fed President William Poole dissented, saying the deal was ``unnecessary'' because of the size of the European Central Bank's and Swiss National Bank's dollar reserves.

Poole wasn't immediately available to respond to questions, spokesman Joe Elstner said.

The Dec. 11 quarter-point cut disappointed investors seeking a larger move and caused the biggest stock sell-off after a Fed decision since Chairman Ben S. Bernanke, 54, took office in 2006. Bernanke, approaching the midpoint of his four- year term, has sought to separate the Fed's strategies of extending the six-year economic expansion and alleviating financial strains.

`Somewhat Restrictive'

Policy makers at the meeting judged monetary policy to be ``somewhat restrictive,'' with growth risks increasing, the minutes said. The report contains no mention of debate over the size of the rate reduction other than a mention of Boston Fed President Eric Rosengren's dissent in favor of a half-point move.

Traders increased bets today the Fed will lower the target rate for overnight loans between banks by a half-point to 3.75 percent on Jan. 30. The likelihood rose to 26 percent, from zero yesterday, based on contracts quoted on the Chicago Board of Trade. Futures show a 74 percent chance of a quarter-point move.

Investors anticipate that policy makers will lower borrowing costs further to help sustain the six-year economic expansion. The Institute of Supply Management today reported that its gauge of U.S. manufacturing slumped to the weakest in almost five years.

Squeeze Eased

Signs of distress in bank funding and credit markets have diminished since the Fed acted in concert with counterparts in Europe to inject funds into money markets. The Fed, ECB, Swiss National Bank, Bank of England and Bank of Canada announced the initiative a day after the FOMC meeting.

The premium of three-month dollar loans between banks over U.S. Treasury bills maturing in the same period fell today to the lowest in almost two months. The so-called ted spread has fallen as the three-month London Interbank Offered Rate for the dollar dropped to 4.68 percent from 5.13 percent Dec. 10.

The U.S. central bank last month introduced a new tool, the Term Auction Facility, to provide funds to banks beyond the one- day maturity in the federal funds market. The Fed held two auctions totaling $40 billion and plans two this month, with continued sales ``for as long as necessary,'' the Fed said Dec. 21.

Fed officials also announced Dec. 12 a $24 billion swap- line with the ECB and Swiss National Bank to help meet demand for dollars among banks in Europe.

Conference Call

Today's minutes disclosed that the FOMC and Board of Governors discussed the auctions and swaps in a Dec. 6 conference call. The Board of Governors approved the auction facility in a Dec. 10 notation vote, the minutes showed.

``A few'' officials ``questioned the need for and the likely efficacy of the proposal, expressed concerns about about the longer-run incentive effects of a TAF, and felt that the possible drawbacks could well outweigh any benefits,'' minutes of the Dec. 6 call said.

The U.S. economy, the world's largest, grew at a 1 percent pace in the fourth quarter after expanding at a 4.9 percent rate the previous three months, according to the median estimate of economists surveyed by Bloomberg News last month. Growth for all 2008 is projected at 2.3 percent.

The Fed's statement last month said that ``some inflation risks remain.''

Inflation Rate

Inflation, measured by the Commerce Department's personal consumption expenditures price index minus food and energy, was 2.2 percent in November, the highest since March. Fed officials in October forecast the ``core'' gauge will rise 1.6 percent to 1.9 percent in 2010, an indication of their preferred longer- term range.

While Fed policy makers expected core inflation to ``trend down a bit over the next few years,'' officials were still ``concerned about upside risks to inflation stemming from elevated prices of energy and non-energy commodities; some also cited the weaker dollar.''

Housing figures show the industry has yet to indicate a bottom to the slump, now in its third year. In November, sales of new homes fell more than economists forecast to a 12-year low, while sales of previously owned homes unexpectedly rose only as prices declined, reports showed the past week.

``Participants agreed that the housing correction was likely to be both deeper and more prolonged than they had anticipated in October,'' the minutes said.

Rosengren Dissent

Rosengren, in his first dissent, saw ``heightened risk of continued economic weakness'' from housing, consumer spending and financial markets, the minutes said.

Investors may get more detail on the Fed's direction in remarks from Vice Chairman Donald Kohn tomorrow at a conference in New Orleans. In November, Kohn reinforced forecasts for a December rate cut by highlighting concern about ``deterioration'' in financial markets.

Also, the Labor Department on Jan. 4 will release its monthly employment report, among the most closely watched releases for Fed officials and economists.