U.S. economy in uncharted waters, Fed says

By Pedro Nicolaci da Costa

PHILADELPHIA (Reuters) - The U.S. economy faces considerable downside risks stemming in part from an unprecedented spike in foreclosures that shows no sign of abating, Philadelphia Fed economists said on Friday.

The Fed has taken dramatic steps to buffer the downturn, including steep interest rate cuts, although this does not mean growth will bounce right back.

"It's amazing how much things have deteriorated in the past month," said Herb Taylor, economist and corporate secretary at the Philadelphia Fed at a media workshop inside the central bank. "We are in uncharted territory."

He pointed to the Philly Fed's recent forecasting survey, which suggests the economy will contract over the next few months before returning to anemic growth rates in mid-2009, but added that the downside risks were considerable.

Asked about the potential for deflation to take hold now that commodity prices have tumbled, Taylor said the ability to pay interest on bank reserves gave the Fed additional tools to fight any persistent and damaging price declines.

"We have the quantitative measures in place to keep the liquidity going," Taylor said. "Whether it would work or not is an open question."

The Fed's economists saw little sign of improvement in the troubled housing market, which helped spark the country's financial crisis.

"Until now, there's no sign of deceleration," said Wenli Li at a media workshop at the Philly Fed.

Li added that uncertainty surrounding housing laws had delayed the mortgage renegotiation process, driving lenders to adopt a "wait-and-see" policy that made the situation worse.

(Reporting by Pedro Nicolaci da Costa; Editing by Tom Hals)