Fed downgrades forecast of future economic activity

~ Higher inflation and unemployment are expected

WASHINGTON -- On Wednesday, the Federal Reserve lowered its projection for economic growth this year, citing damage from the double blows of a housing slump and credit crunch. It said it also expects higher unemployment and inflation.

The updated forecasts come at a time Federal Reserve chairman Ben Bernanke and his colleagues are concerned the economy could continue to weaken, even after their aggressive interest rate cuts in January, according to minutes of those private deliberations released Wednesday.

"With no signs of stabilization in the housing sector and with financial conditions not yet stabilized, the committee agreed that downside risks to growth would remain even after this action," according to minutes of the Fed's Jan. 29-30 closed door meeting.

The Fed at that session voted to cut a key interest rate by one-half percentage point to 3 percent. Just eight days earlier, the Fed, in an emergency session, slashed its rate by a rare three-quarters percentage point. The two rate cuts together marked the most dramatic rate reductions in a single month by the Fed in a quarter century.

Under its new economic forecast, the Fed said that it now believes the gross domestic product will grow between 1.3 percent and 2 percent this year. That's lower than a previous Fed forecast for growth, which at that time was estimated to be between 1.8 percent and 2.5 percent.

The GDP is the value of all goods and services produced within the United States and is the best barometer of the country's economic fitness.

With economic growth slowing, the Fed projected that the national jobless rate will rise to between 5.2 percent and 5.3 percent this year. That is higher than the central bank's old forecast for the rate to climb as high as 4.9 percent. Last year, the unemployment rate averaged 4.6 percent.

And, with energy prices heading upward, the Fed also raised its projection for inflation. The Fed now expects inflation to be between 2.1 percent and 2.4 percent this year. That's higher than its old forecast for inflation, which was estimated at around 1.8 percent to 2.1 percent.

The Fed said its revised forecasts reflected a number of factors including "a further intensification of the housing market correction, tighter credit conditions ... ongoing turmoil in financial markets and higher oil prices."

Complicated work

The combination of slower economic growth and increasing inflation could complicate the Fed's work. The central bank is trying to keep the economy growing, while ensuring that inflation stays under control. The Fed's remedy for a weakening economy is interest rate cuts. To combat inflation, the Fed usually boosts rates.

Oil prices on Wednesday climbed to a new record -- topping $100 a barrel. Consumer prices, meanwhile, rose by a bigger-than-expected 0.4 percent in January, according to new government figures released Wednesday.

While some believe inflation concerns could lead the Fed to cut rates by a modest one-quarter percentage point at its next meeting on March 18, many are still predicting another half-point reduction.

"Job No. 1 at the Fed is to right this potentially sinking ship even as inflation continues to percolate," said Richard Yamarone, economist at Argus Research. He and other economists believe the Fed was sending a message that the risk of recession outweighed the danger of inflation -- for now, anyway.

On Wall Street, the hope of more rate cuts lifted stocks. The Dow Jones industrials closed up 90.04 points.

Fed policymakers were mindful that they needed to keep a close eye on inflation, minutes of the Jan. 29-30 meeting said.

And, some policymakers noted that when prospects for economic growth improved, "a reversal of a portion of the recent easing actions, possibly even a rapid reversal, might be appropriate," according to the documents.

Still, all but one of the Fed's members agreed to lower rates by a half-point at that time.

Richard Fisher, president of the Federal Reserve Bank of Dallas was the sole dissenter. He preferred no change. The minutes showed that Fisher felt that the level of interest rates was already "quite stimulative, while headline inflation was too high."

For next year, the Fed expects economic growth to pick up a bit and for inflation to moderate. The unemployment rate could ebb to 5 percent or hover as high as 5.3 percent, according to the Fed's forecast.

The minutes also showed that the Fed conducted a conference call on Jan. 9 where policymakers reviewed economic data and financial market developments, which were worsening. It did not lower interest rates at that time, although most policymakers were of the view that "substantial additional policy easing in the near term might well be necessary" to help brace the wobbly economy.

As the financial situation continued to deteriorate, worldwide stocks markets plunged and recession fears intensified, Bernanke convened an emergency conference call on Jan. 21. Fed policymakers believed "the outlook for economic activity was weakening," details of that conference call showed. The Fed decided to slash rates by a dramatic three-quarters of a percentage point and make the announcement on the following morning, Jan. 22.

Demonstrating the Fed's "commitment to act decisively" to support the economy might reduce concerns about the weakening economy that seemed to be contributing to the worsening state of financial markets, according to the minutes. However, there was some concern expressed that such a bold move "could be misinterpreted as directed at recent declines in stock prices, rather than the broader economic outlook," the documents showed.

William Poole, president of the Federal Reserve Bank of St. Louis, was the lone dissenter on the Fed rate cut announced on Jan. 22. He did not believe conditions justified a rate cut before the Fed's regularly scheduled meeting on Jan. 29-30, the minutes said.