The US Federal Reserve has chopped back its 2008 forecast for American economic growth, holding out the possibility that the economy could slow to stalling speed in the first half.

The Fed lowered its growth target for the US economy in 2008 in the new forecasts which were issued as an addendum to the minutes of the October 31 meeting that cut the Federal Funds rate by 0.25%.

The Fed now expects the US economy to grow at about a 1.8% to 2.5% next year, down from a forecast in June of 2.5% to 2.75% growth.

Third quarter GDP rose at an annual rate of 3.9%: this quarter is expected to see a sharp fall to around 1.9% to 2.2%, so there will be a further decline in the first half of next year at even lower growth rates that could be as low as 1.5% or less, which is close to stalling speed for an economy like the US.

In its first set of longer term forecasts and comments on growth, inflation and other economic factors for the US economy, the Fed has also tried to reduce expectations that it will cut rates whenever the economy slows or inflation is falling. 

Economists said the commentary in the new forecasts is attempting to reduce these expectations because the Fed no longer believes the US economy can grow at much more than 2.5% per cent a year without generating higher inflation.

The Fed cited “tightened terms and reduced availability of sub-prime and jumbo mortgages, weaker-than-expected housing data, and rising oil prices” as the main reasons for revising its 2008 projections downward.

Fed members forecast that could slow next year to as low as 1.8%, according to the middle range of forecasts. The Fed said the numbers were “notably below” the 2.5% to 2.75% anticipated in June.

US unemployment, now running around 4.7%, would rise “modestly” next year. The Fed said that, as measured by the personal consumption expenditures price index excluding food and energy (a measure of core inflation used by the Fed), inflation will range from 1.7% to 1.9% in 2008, compared to the June forecast of 1.75% to 2%.

So there would seem to be a core of inflation that will remain in the US economy, despite the accelerating slowdown in activity now underway. That would mean that the Fed probably won’t be as quick to rate cuts much further than what the market reckons will happen next month.

No forecast on rates was given but it would seem that a low of 4% to 4.25% for the Federal Funds Rate may now be seen by US markets.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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