Goldman sees deeper recession, jobless rate 8.5 pct

NEW YORK (Reuters) - The United States is sinking into a recession deeper than previously forecast, with the jobless rate rising to 8.5 percent by the end of 2009, Goldman Sachs said on Friday.

Jan Hatzius, senior economist at the bank, cited a recent "accumulation of evidence that U.S. domestic demand and production continue to fall sharply" as the economy founders under the persistent strain of the most severe credit crisis in many decades.

U.S. employers cut payrolls by 240,000 in October and the national jobless rate shot up to 6.5 percent from 6.1 percent in September, a government report showed on Friday.

"Today's labor market report confirms the message that had already been suggested in the September data, namely that these developments have prompted business firms to accelerate the process of cutting payrolls to keep pace with falling demand and output," Hatzius wrote in a research note.

Goldman sees unemployment likely to continue rising in 2010 as the economy struggles with an excess supply of houses under credit conditions that will be looser than now, but still restrictive.

The bank has marked down its near-term forecasts for the economy, expecting gross domestic product to shrink an annualized 3.5 percent in the fourth quarter, deeper than the previously forecast 2 percent contraction.

For the first quarter 2009, the bank expects 2.0 percent annualized contraction, weaker than the previously forecast 1.0 percent shrinkage, Hatzius wrote.

To combat the sliding economy, the Federal Reserve is expected to cut interest rates further. Goldman anticipates 50 basis points of rate cuts by year end, which would reduce the U.S. fed funds target rate to 0.5 percent from the current 1.0 percent. The current level is already the lowest since 2004, when it was at a four-decade trough for short-term interest rates.

(Reporting by John Parry; Editing by Dan Grebler)