LONDON (AFX) - Merrill Lynch economists this morning said they now expect to see a recession in the US. As a result of this change in scenario, they believe the Fed funds could drop to 2 pct against their current level of 3 pct. The group, which was already one of the most bearish in the market, also had little comfort for European investors, who are again feeling the pinch today with European bourses all down by at least 3 pct this morning. Merrill Lynch has cut its growth estimate for the Eurozone to 1.25 pct in 2001, while they said the consensus is expecting growth of 2 pct. For 2002, the US broker now expects growth of 1.5% in 2002, versus consensus forecasts of 2.5%. Merrill Lynch's previous estimates were not immediately available. They expect the ECB repo rate to tumble further, after Monday's 50 bp cut which brought the rate down to 3.75 pct. The strategists also cut their corporate earnings forecast for the zone to a fall of 15 pct in 2001 and 0 pct growth in 2002. For the UK, Merrill economists cut EPS growth numbers to 3 pct in 2001 and 6 pct in 2002. They added they will not turn positive on European equities until they see negative real US short rates, lower oil prices, a drop in US consumer confidence and a fall in European earnings forecasts. The economists said optimists should focus on monetary stimulus - the 30 year yield curve is at its steepest since 1990; 5-year US yields are at the same level as in 1963 and there are unprecedented liquidity injections (Fed funds has been trading at 1 pct in the last few days). "This policy should form the basis for an eventual market recovery," they said. In the meantime, they said investors should remain defensive, believing bear market stocks will continue to outperform. Once capital markets stabilise, the rally should be led by financial and industrial blue chips, they added.