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UPDATE 2-Fed saw big risks to economy despite low rates-minutes
By Mark Felsenthal WASHINGTON, Jan 6 (Reuters) - Federal Reserve officials believed the U.S. economy would face 'substantial' risks even as benchmark interest rates were cut to near zero, with some worrying about the risk of deflation, minutes of a December rate-setting meeting released on Tuesday showed. At the Dec. 15-16 meeting, the U.S. central bank chopped overnight borrowing costs to a range of between zero and 0.25 percent, and with rates pushed to the floor, signaled it was ready to try to lift the economy by pumping vast amounts of money into distressed financial markets. 'Even with the additional use of nontraditional policies, the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial,' the Fed minutes said. Fed officials took note of the crumbling jobs market and flagging output and concluded the economy would contract sharply in the last three months of 2008 and in early 2009. Some worried about an even more prolonged contraction. Fed staff revised down sharply their outlook for economic activity in 2009 but projected a moderate recovery in 2010, the report showed. U.S. growth was expected to fall much more sharply in early 2009 than previously anticipated and decline for the year as a whole. 'These minutes are a shock to the senses -- a stark reminder of the current weak environment we're in,' said Brian Dolan, chief currency strategist at FOREX.com, in Bedminster, New Jersey. Wall Street stock markets rallied and the U.S. dollar pared gains against the euro after the minutes were released as investors bet on further aggressive government actions to stimulate the recession-mired economy. The blue-chip Dow Jones industrial average closed up 0.69 percent. ENTERING A NEW ERA In announcing their decision to cut interest rates on Dec. 16, the Fed said it expected weak economic conditions to warrant unusually low rates 'for some time.' The minutes showed that policy-makers wanted to send a clear message that they intended to keep interest rates very low for an extended period to stimulate the economy and prevent a damaging deflationary spiral. 'Participants judged that communicating the committee's expectation that short-term interest rates were likely to stay exceptionally low for some time could be useful,' the report said. Expectations of low short-term interest rates can help lower the longer-term rates set in financial markets. The U.S. economy slid into recession in December 2007 in the wake of the collapse of the U.S. housing market and a severe credit crunch that has hammered growth rates worldwide. U.S. unemployment hit a 15-year high of 6.7 percent in November, and a report on Friday is expected to show it climbed to 7 percent last month. With interest rates at or near zero, Fed officials discussed how else they could breathe life into the economy and prevent sustained deflation, a broad decline in prices that could further sap activity by causing consumers to delay purchases. They revived consideration of setting more explicit goals for inflation, a step some officials believe could help in a deflation fight. Policy-makers also discussed how best to use the Fed's balance sheet once they exhausted their interest-rate cutting options. The balance sheet would likely need to remain at a high level for some time, and policy-makers discussed, but set aside, the idea of setting quantitative targets for bank reserves or the money supply. The Fed has already launched a number of unconventional programs aimed at breaking the logjam in credit markets and reviving growth. On Monday it began buying mortgage-backed securities, and it has said it is considering buying longer-term Treasury securities. At the December meeting, officials agreed that buying large quantities of longer term securities could help by lowering interest rates and borrowing costs for many people, although they were uncertain how large an impact such moves would have. Officials also supported expanding and creating new lending facilities to restore lending. ((To access other stories on Fed policy, please click on )) (Additional reporting by David Lawder; editing by Leslie Adler) ((E-mail: [email][email protected][/email]; +1-202-898-8329; Reuters Messaging: [email][email protected][/email])) Keywords: USA FED/ (Multimedia versions of Reuters Top News are now available for: * 3000 Xtra: visit [url]http://topnews.session.rservices.com[/url] * BridgeStation: view story .134 For more information on Top News: [url]http://topnews.reuters.com[/url]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.