Recession more severe than thought: Fed's Rosengren

WEST NEWTON, Massachusetts (Reuters) - The U.S. recession looks to be longer and more severe than originally thought, but there are signs that the economy will improve in the second half of 2009, a top Federal Reserve official said on Thursday.

"It appears the economy contracted quite significantly in the final quarter of 2008 and may continue contracting over at least the first half of 2009. We are seeing businesses retrenching and unemployment rising," Boston Federal Reserve Bank President Eric Rosengren told the Massachusetts Mortgage Bankers Association's Annual Meeting.

"As a result, this recession looks to be longer and more severe than originally forecast. Still, there are indications that the second half of the year will show improvement," he said.

Lower energy prices and concerted monetary and fiscal policy efforts should set the stage for a recovery later in 2009, he said.

"Energy prices have fallen dramatically, making it much less expensive to drive cars or heat homes," he said, "Fiscal stimulus packages being discussed in Washington could provide an economic boost. And monetary policy is also contributing," he added.

The Federal Reserve last month cut its benchmark fed funds rate to a range of zero to 0.25 percent after an aggressive rate cutting cycle and has rolled out a raft of unprecedented liquidity programs to support key credit markets in its effort to battle the worst financial crisis in 80 years.

"While all these developments will take time to fully impact the economy, they should be sowing the seeds of a recovery later in 2009," he said.

Rosengren said recent actions by the Fed to reduce mortgage rates, such as its agency mortgage-backed security and agency debt purchases, have driven mortgage rates down.

The plethora of other emergency liquidity facilities have also had a positive effect on credit markets, Rosengren said.

Answering an audience question after his speech, Rosengren said the ballooning Federal Reserve balance sheet need not necessarily lead to inflation down the road and that concerns about deflation and an extended period of economic weakness were greater.

"By supporting short-term credit markets, the Federal Reserve is signaling its determination to take appropriate actions to prevent seize-ups in financial markets, reducing the risk premium," Rosengren said in his speech.

"We have seen improvements of late in the functioning of many short-term credit markets and I expect this improvement will continue."

Rosengren, who won't assume a voting seat on the Fed's policy-setting committee until 2010, said that with appropriate steps, the housing market could stabilize this year. A recovery in the housing market is widely seen as a prerequisite for economic recovery.

"The recent reductions in mortgage rates, in part due to monetary policy actions, have enabled more borrowers than would otherwise have done so to purchase or refinance homes," Rosengren said.

"Expansion of this effort and encouraging greater GSE participation, should encourage borrowers that have equity and reasonable credit scores to purchase or refinance homes," he added.

Rosengren said the government-sponsored enterprises (GSEs) Fannie Mae (FNM.P) and Freddie Mac (FRE.P) "could play a more significant role in restoring liquidity and providing a secondary market for mortgages that reflect the lower cost of funds in many credit markets."

For more troubled borrowers, Rosengren said Federal Housing Administration (FHA) lending programs could be appropriate.

Rosengren also said that once the market has stabilized, mortgage securitization should be structured in such a way to reduce the likelihood of future upheaval in mortgage finance.

"And more generally, financial regulatory reform will also be a key policy topic this year," he said.

(Reporting by Kristina Cooke; editing by Gary Crosse)