Oct. 17 (Bloomberg) -- The outlook for the U.S. economy is ``very sluggish'' well into next year, while inflationary pressures are easing, said Charles Evans, Federal Reserve Bank of Chicago president.

``The outlook for real economic activity likely will result in production, spending and labor markets being very sluggish'' for a period ``well into 2009,'' Evans said in the text of remarks to be delivered in Fond du Lac, Wisconsin. ``I expect that such activity will then pick up as the housing and financial markets gain headway in working through their problems.''

With the economy weakening under the impact of the 14-month financial crisis and housing recession, and consumer prices easing, most investors anticipate the Fed will lower interest rates by at least a quarter point when they meet Oct. 28-29. Evans's bank compiled the Fed's Beige Book report two days ago, which showed the economy weakening across all regions.

``The housing market is a continuing strain, and we are experiencing disruptions in worldwide credit markets that are without precedent in the post-World War II era,'' Evans said. ``Such challenges call for innovative and vigorous fiscal and monetary-policy responses.''

Coordinated Action

The Fed, European Central Bank and four other central banks cut interest rates last week in an unprecedented coordinated effort to prevent frozen credit markets from causing a global recession. The Fed reduced its benchmark to 1.5 percent.

While an official declaration of a recession hasn't been made, this year's jump in the unemployment rate may be indicative of one, Evans told reporters after his speech. ``The unemployment rate rarely goes up as it has without that eventually happening,'' he said. ``We are facing tremendous economic challenges.''

Evans didn't directly comment on his outlook for interest rates. He did note that the current rate is at an ``historically low level.''

``Although some risks to the inflation outlook remain, a forward-looking assessment would put less weight on inflation concerns than earlier this summer,'' Evans said at Marian University. While inflation has been ``high,'' commodities prices have fallen and ``the increased slack in the economy will likely reduce more general cost and inflationary pressures,'' he said.

Winning on Inflation

Evans's comments reflect Fed officials' rising confidence that the threat of higher prices is decreasing. The Federal Open Market Committee, in its statement last week, cited a ``reduction in inflationary pressures'' from energy and other commodities.

The consumer price index was unchanged in September after falling in August, the first time in almost two years that the measure hasn't increased, government figures showed this week. Prices increased 4.9 percent in the 12 months to September after a year-over-year gain of 5.4 percent in August.

Construction of single-family homes dropped 12 percent last month to a 544,000 annual rate, the Commerce Department said today in Washington. Starts on all residential properties, including condominiums, slid to a 817,000 pace, below all 74 forecasts in a Bloomberg News survey.

``Housing starts were down today by a large amount,'' Evans said during the audience question period, adding that the market has a ``very large inventory'' of unsold properties.

Bernanke Assessment

Fed Chairman Ben S. Bernanke said this week the government's purchases of up to $250 billion in bank stakes and a guarantee of debt will revive financial confidence and promote ``vigorous, healthy'' economic growth. The Treasury is making equity investments in banks as part of a $700 billion rescue plan approved by Congress this month.

``These efforts will be of great help in unlocking lending capacity, enhancing the flow of credit to consumers and businesses, and moving us toward financial stability,'' Evans said. ``But bringing credit markets back into full functionality won't happen overnight.''

Interbank lending rates ``are substantially elevated and they have been for a long time,'' Evans said during the audience question period. ``Banks and other financial institutions are under a great deal of strain at the moment. Few institutions are desiring to lend at term. They are more likely to lend overnight.''

The Fed is facing increasing evidence that the U.S. may already be in a recession. Labor Department figures showed Oct. 3 that payrolls fell by 159,000 in September, the biggest reduction in five years. The unemployment rate was 6.1 percent, an increase from 5 percent as recently as April.

Rising unemployment and high prices have contributed to ``marked weakness in consumer spending,'' Evans said. Recent data suggest spending declined again in September, he said.

Retail sales fell 1.2 percent in September, extending their decline to a third consecutive month, the longest slump in at least 16 years.

To contact the reporter on this story: Steve Matthews at smatthews@bloomberg.net

Last Updated: October 17, 2008 16:00 EDT