Fed braces for weaker growth ahead

Robust US expansion in the third quarter may be the last ray of sunshine the Federal Reserve sees before the full impact of a housing downturn and tighter credit conditions darken the economy's prospects.

The US central bank meets today and tomorrow and is expected to lower the benchmark interbank federal funds rate by at least a quarter percentage point to 4.50 per cent as insurance against the risk that shocks from declining house prices and higher borrowing costs could tip the economy into recession.

Fed officials expect the economy to slow because of the credit crisis that hit over the summer after worries about sour mortgage loans spread, though strong exports and steady hiring and spending have buoyed the world's largest economy so far.

Analysts anticipate expansion at a three per cent annual rate from July through September when the government publishes its first estimate of third-quarter gross domestic product on the morning the Fed's policy-setting Federal Open Market Committee is due to announce its decision in interest rates.

But the outlook for the final three months of the year is for a rapid deterioration caused by lingering weakness for home sales and construction, softer consumer and business spending, and slower job growth.

"Looking ahead, the housing market is just tremendously troubling," said Carl Tannenbaum, chief economist for LaSalle Bank ABN Amro in Chicago.

"Clearly all of the risk for economic growth is for the downside," he said.

Fed officials concede that housing will contract further and exert a "significant" drag on growth into next year. That said, the impact of the housing downturn on business and consumer spending remains uncertain, they have said.

And while financial markets have experienced some improvement since the worst of the credit crunch mid-August, a full recovery will probably take some time and may be uneven, officials say.

"Our policy action will not be able to avert all of the weakness in the economy that may be in train for the next several months," Fed Governor Donald Kohn had said.

As a result, next year's growth outlook looks lower than the 2.5 per cent to three per cent range the Fed forecast in July, a direct result of tightening credit and likely retrenchment of household and business spending, analysts believe.

In the meantime, the Fed will continue to have to balance risks to growth with lingering concerns that, as energy prices rise and the US dollar weakens, inflation may flare.