Fed could keep rates near zero all 2009: Lockhart

ATLANTA (Reuters) - The Federal Reserve has "ample scope" to aid an extremely weak U.S. economy and could hold interest rates near zero for the rest of 2009 or longer if needed, one of its top policy-makers said on Monday.

"The Federal Reserve has not exhausted its policy tools. The policy arsenal available to the Federal Reserve remains a powerful corrective force on the economy," Dennis Lockhart, president of Atlanta Federal Reserve Bank, said in speech.

The collapse of the housing market tipped the United States into recession in December 2007, sparking the worst financial crisis since the Great Depression and costing 2.6 million jobs last year as unemployment soared.

The Fed has unleashed an array of measures to restore growth, more than doubling the size of its balance sheet to over $2 trillion, while shifting the type of the assets it buys to ease credit market conditions.

"Even with the federal funds rate effectively at zero, there is ample scope to do more of both if conditions require," Lockhart, a voting member this year on the Fed's interest-rate setting committee, told the Rotary Club of Atlanta.

The Fed cut its benchmark overnight funds rate target to between zero and 0.25 percent on December 16 and Lockhart said this would deliver a powerful boost to the economy.

"A federal funds rate this low will have considerable macroeconomic effect especially if accompanied by policies to improve the functioning of credit markets," he said.

Some economists think the Fed will keep rates unchanged for the duration of 2009 and into 2010, and Lockhart gave an unusually clear hint that this guess was on the money.

He said that a reference to "some time" in the central bank's statement last month, when the Fed announced its aggressive rate move, was designed to signal a prolonged period of very easy policy.

"What does 'some time' mean? I don't have a definition of 'some time.' Until conditions dictate otherwise, is one answer, and at some stage we will look at our outlook and determine if it is time to perhaps reverse that policy.

"But it was meant to convey...that certainly for a good part of this year we could expect rates in that range and perhaps longer -- all dictated by conditions that exist in the future, when we're looking at the stance of policy," he told reporters after the speech.

Lockhart said the economy may have declined by between 4 percent and 6 percent at an annual pace in the last quarter of 2008 and may fall at that rate in the current quarter.

It should start to recover in the second half of this year as powerful policy stimulus gains traction, he said, but the situation remains fragile.

"There is always the risk of a shock or reversal in the financial sector or elsewhere that could again alter the outlook to the downside," Lockhart said.

However, he did not share the fears of some private-sector economists that the United States faced a Japan-style deflation, where a prolonged decline in general prices sapped consumer spending and made its 1990s recession much worse.

"At this time I don't see any realistic risk of deflation," he said.

"One of the reasons that I emphasize the ammunition that the Federal Reserve has is that in the event that we see signs of actual deflation, as opposed to disinflation, we have measures that we can take to try to counter that," he said.

Economists expect U.S. headline inflation to decline on a year-on-year basis during the course of 2009 due to the collapse in oil prices from a $145 per barrel peak last July to around $38 a barrel currently.

In addition to slashing interest rates by 5.25 percentage points since September 2007, the Fed has applied a number of unconventional policy tools to restore growth.

It has pumped hundreds of billions of dollars into credit markets frozen in panic over mammoth losses from the collapse in U.S. housing. Lockhart said these steps were beginning to deliver some relief, but the economy was not out of the woods.

"We've seen improvement since the worst period in September and October, but, all in all, financial conditions going into 2009 are still unsettled," he said.

(Editing by Leslie Adler)