Fed to Cut Rates to Zero on Deflation Risk, JPMorgan Predicts

By Jason Clenfield

Nov. 20 (Bloomberg) -- The U.S. Federal Reserve will probably cut interest rates to zero percent over the next two months to staunch deflation, according to JPMorgan Chase & Co.

The Fed will lower borrowing costs by 50 basis points at each of the next two policy meetings on Dec. 16 and Jan. 28, JPMorgan economist Michael Feroli wrote in a note to investors yesterday. The central bank will hold rates at zero for the rest of 2009 to prevent prices from spiraling down as companies cut jobs and banks reduce lending, stifling spending, Feroli said.

The Fed may not be the only central bank to begin offering free money to jolt life into their recessionary economies and keep prices rising as the 15-month credit crisis deepens. The Bank of Japan cut its benchmark rate to 0.3 percent last month, and the European Central Bank has signaled it's ready to lower rates further after two reductions in the past six weeks.

U.S. consumer prices plunged 1 percent last month, the most since Labor Department records began in 1947, the government said yesterday. Some Fed members indicated a willingness to cut rates to spur growth and keep prices from falling, according to minutes from the last Federal Open Market Committee meeting that were released hours after the price report.

``Taking the target rate to zero percent would not be costless for the Fed,'' Feroli said. Public confidence may drop ``if there is a perception that the Fed has `run out of ammo.'''

Fed officials cut their forecasts for inflation and growth at the Oct. 28-29 meeting. Some members saw a risk that the inflation rate will fall below the Fed's objective of ``price stability.''

Feroli said cutting the key rate to zero from the current 1 percent wouldn't exhaust the central bank's tools. The Fed could become ``more aggressive'' by purchasing the debt of Fannie Mae, Freddie Mac and other government-chartered mortgage financing companies, Feroli said.

``The path of least resistance may be for the Fed to first communicate to the markets that the nature of the current economic woes should keep rates low for an extended period,'' Feroli said.

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net