Standard & Poor's expects the U.S. Federal Reserve to cut interest rates to 3.5 percent in 2008 to deal with the fallout from the housing market, S&P's chief European economist said  at a banking conference in London.

"There is a good chance we reach about 3.5 percent for Fed funds ... by late summer 2008," Jean-Michel Six told investors. He said S&P now put the probability of a U.S. recession over the next 12 months at 40 percent and forecast economic growth of 1.8 percent in 2008.

"Below 2.0 percent for the U.S. is a very, very low speed, almost close to stalling." He said the unemployment rate was the key factor in whether a recession would become more likely. In terms of the housing market, S&P believes only half of the correction in prices has occurred so far. It expects house prices to fall 10 percent in total from peak to trough. "There is much more pain, much more hardship ahead," Six said. The Fed lowered its U.S. economic growth forecast sharply on Tuesday. It now projects U.S. growth to slow in 2008 to between 1.8 and 2.5 percent, sharply down from the 2.5 to 2.75 percent forecast in June, before picking up in 2009. Minutes from the Fed's October meeting also showed its rate cut to 4.5 percent was a close call.

The Fed said it was unsure last month whether lower borrowing costs were needed to cushion the U.S. economy from a housing slump and credit woes but decided to cut interest rates as a form of insurance.