Goldman Sachs Groups Inc. said on Wednesday the U.S. economy is likely to drop into recession this year leading the Federal Reserve to cut interest rates by 2.5 percent by the third quarter.

The global investment bank said in a note to clients there is an 88 percent chance that the Federal Reserve will lower its target for overnight rates to 3.75 percent from 4.25 percent at its next policy meeting on January 30, as February fed funds futures rose 0.02 points to 96.19.

Goldman previously said in November the Fed would reduce its key interest rate to 3 percent by the middle of 2008. Since September, the Fed cut rates at all of the last three meetings of the Federal Open Market Committee, dropping the target rate on loans between banks by 1 percentage point from 5.25 percent.

Two government reports released last week added to Goldman Sachs' analysis. The jobless rate rose to 5 percent in December making it the highest rate in two years. Payrolls rose by 18,000 in November, the least since August 2003, evidence the economic expansion is cooling after a third-quarter surge.

Goldman recommended that investors increase their holdings of healthcare, consumer-related, energy and utility stocks. Meanwhile, stocks the group advised fund managers to underweight were financials, industrials, materials and information technology.

The three most significant changes to their sector recommendations are the reduction in the financial sector weighting by 300 basis points to 14 percent, the information technology weighting by 400 basis points to 15 percent, and the increase in their health care weighting by 300 basis points to 17 percent, the report said.

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