Negative rates work their way on to radar for a few at the Fed

By Jonathan Spicer

NEW YORK, Oct 15 (Reuters) - Signs the U.S. economy is feeling the drag from a slowdown overseas is raising questions about the Federal Reserve's plan to lift rates this year, and even prompting some officials to ponder what tools it may need if things get worse.

Consumer prices in the world's largest economy recorded their biggest drop in eight months in September as gasoline prices slumped. Also last month, U.S. producer prices logged their biggest fall in eight years.

Weak recent job growth and retail sales added to the gloom in an economy that is starting to feel the pain of a slowdown in China and other emerging markets, falling commodity prices, and a dollar that has risen for more than a year. All of that is keeping U.S. inflation well below the Fed's 2-percent goal.

Two influential Fed governors this week urged a delay in tightening despite repeated messages from Chair Janet Yellen and others that "liftoff" was likely to come this year.

Some Fed officials also appear to have reconsidered a stimulus tool that had been dismissed as too risky: negative interest rates.

At least six current Fed policymakers over the last two weeks have publicly discussed charging banks to park funds at the central bank. Four suggested it would be worth considering if the recovery falters badly and one, Minneapolis Fed President Narayana Kocherlakota, urged an immediate cut below zero.

"Once unthinkable, the fact negative rates are creeping in the public debate mean we can't dismiss them anymore," said Standard Chartered senior economist Thomas Costerg.

The controversial idea of charging fees on some deposits could prompt banks to send funds not to the central bank but into the economy. In 2008 and again in 2012, the Fed considered negative rates but shelved it for fear it would spook investors and stress money market funds already under pressure from rates set in the 0-0.25 percent range, where they remain today.

But in the last two years, the European Central Bank and its counterparts in Switzerland, Sweden and Denmark have used a version of the tool with some success.

That, along with erratic economic growth and stubbornly low inflation back home may have won over some Fed skeptics and left the door open to negative rates in the United States if a recession threatened.

"I am watching, and I'm sure my colleagues are watching with great interest to determine whether central banks have such a tool if needed in the future," Atlanta Fed President Dennis Lockhart said last week of what he called "experiments" in Europe.

Fed Governor Lael Brainard flagged negative rates in a speech on Monday, saying "we will benefit from studying and learning about" Europe's experience. She said any tightening should be delayed.

STILL BANKING ON A HIKE, THOUGH TIMETABLE SLIPPING

To be sure, Fed policymakers have stressed that a rate hike and not a cut, is far more likely.

Based on September forecasts, they expect to lift rates once this year and to get them above 1 percent by the end of 2016.

New York Fed President William Dudley discussed negative rates in a TV interview but dismissed the idea. Lockhart said the idea of using the tool "in the near term is not very plausible to me."

Some economic signposts, such as a drop in applications for jobless benefits to a 42-year low and rising demand for housing, have pointed to improved growth prospects in the United States, and consumer prices outside of food and energy edged up a bit last month.

Yet the global slowdown and questions over China's prospects already prompted the Fed to delay a rate hike last month.

Primary dealers in a poll last month gave a 10 percent chance of a U.S. recession, and a 20 percent chance of a global recession, in the next six months.

The weak inflation readings and a sharp brake in hiring in August and September show that U.S. manufacturers and energy firms are struggling with the high dollar and low oil prices.

"The lack of any economic acceleration, despite the degree of accommodation being provided by the Fed, suggests not only that risks of deflation are higher than generally expected but also that the Fed will be on hold longer than is anticipated," said Steven Ricchiuto, chief economist at MSUSA.

(Reporting by Jonathan Spicer; Additional reporting by Ann Saphir in Milwaukee and Jason Lange in Washington; Editing by Andrea Ricci)

• Budget, Tax & Economy