PIMCO expects string of rate cuts

By Ros Krasny

NEW YORK (Reuters) - The Federal Reserve is likely to slash benchmark interest rates by up to 100 basis points in 2007 as U.S. economic growth is stung by weakness in the housing market, Bill Gross, chief investment officer of PIMCO, said on Monday.

But speaking to the Reuters Investment Summit in New York, Gross said the statement to be issued at Tuesday's Federal Open Market Committee meeting likely will be almost identical the most recent versions, with a focus on inflation risks.

"If the statement stays the same (on Tuesday), that puts my forecast back a month or six weeks" in terms of the potential start of a rate-cutting cycle, Gross said via a conference call from Pacific Investment Management Co.'s Newport Beach, California, headquarters.

The FOMC last raised interest rates in June and has held the federal funds rate steady at 5.25 percent at its past three meetings.

Gross, however, said the FOMC could tweak its statement more materially at its two-day meeting in January, in preparation for a rate cut at a later meeting.

"The Fed will probably alert the market to a change with a one or two meeting pre-announcement."

He said that a clear hint from the Fed that rate cuts are on the way could set up further weakness in the dollar. "Once people start to believe that the Fed will have to cut interest rates in the next three to four months, the dollar's decline is going to accelerate," he said.

Over the course of 2007 the dollar could fall more than 5 percent against a basket of currencies, Gross said.

Financial markets have cut the chances of a Fed rate cut by March to about 25 percent after Friday's stronger-than-expected November payrolls report, from over 80 percent following news of weak factory activity issued on December 1. Futures fully reflect a rate cut to 5 percent by June.

Gross said that over time, the housing market downturn would exert more downward pressure on the overall U.S. jobs market and consumer spending, potentially pushing up the jobless rate.

It could be another one to two years before the effects of the housing bubble are unwound, he said.

A combination of higher unemployment and lower capacity utilization would give the Fed "cover" on inflation, making it easier to start cutting rates, he said.

"We're starting to see that, but only in the early stages. It will probably be the end of the first quarter or the start of the second quarter before the Fed will think it has inflation licked," he said.

Gross termed the U.S. economy "bipolar," with the negative side spearheaded by housing while higher export demand and the services sector were positive contributors.

Overall, though, economic growth in 2007 was likely to be in the 1 percent to 2 percent range.  Continued...