Analysts at brokerage giant Morgan Stanley are now forecasting a U.S. recession.

In a research note issued Monday, the firm’s analysts reveal that they are changing their calls for U.S. growth and monetary policy.

“Since the shock of tighter financial conditions surfaced in August, we’ve incrementally reduced our outlook for future growth. But the time for incremental changes is over,” it says. “A mild recession is now likely: We expect domestic demand to contract by an average 1% annualized in each of the next three quarters, no growth in overall GDP for the year ending in the third quarter of 2008 and corporate earnings to contract by 5%-10% over that longer period.”

The firm says that three factors have tipped the balance to the downside: financial conditions continue to tighten, domestic economic weakness is broadening into capital spending, and global growth is slowing.

The likelihood for a recession also has the firm revising its interest rate outlook for the U.S. “Even if the data do not immediately validate our call, we expect the Federal Reserve Board to insure against worse outcomes. That process should start this week with a 25 [basis point] reduction in the Federal funds rate, a 50 bps cut in the discount rate, and possible extensions of term open-market operations to as long as 65 business days to help ease strains in money markets.” Following that, it believes the Fed will ease by at least another 75 bps over the next seven to nine months.”

BCA Research also sees much more downside for U.S. rates: “Whether the Fed cuts rates by 25 bps or 50 bps tomorrow, much more policy easing is in the pipeline.

“Lending conditions are generally tighter than before the Fed began the easing cycle, largely because the banking sector and parts of the credit markets are hamstrung with bad debts. The Fed likely needs to dramatically steepen the swap curve as occurred in the early 1990s and early 2000s, in order to facilitate a healing process,” BCA adds, noting that the spread between the rate that banks lend at and the banks’ funding costs, is at its most inverted level in the history of the series.

“A sharp slowdown in commercial bank lending growth often followed periods when this curve inverted in the past. Such a slowdown has not yet occurred, but may soon be underway,” BCA says, adding that it also foresees a reduction in the Fed’s discount rate.

Morgan Stanley concludes that “a more aggressive Fed, an earnings recession, healthy growth abroad, and a scramble for liquidity all will reinforce our longstanding market calls for steeper yield curves, higher volatility, and challenges for risky assets. While many of these themes are in the price, economic uncertainty may extend them further.”