Fed lowers growth forecast, raises inflation

"Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term," the Fed said in minutes from its April 29-30 policy meeting.

Fed officials said that cutting benchmark interbank lending rates by a quarter percentage point to 2 percent at their last meeting was "a close call," reinforcing the impression that policy-makers may be putting further interest rate moves on hold.

"If you had any doubt that the Fed is signaling a pause, that doubt is gone," said Christopher Low, chief economist at FTN Financial in New York.

In an accompanying forecast, the Fed cut its projection for 2008 growth to a scant 0.3 percent to 1.2 percent, down from the 1.3 percent to 2 percent it forecast three months ago.

At the same time, the U.S. central bank said it expects inflation to remain "elevated" and unemployment to increase "significantly."

Wall Street stocks tumbled after the Fed forecast, with the Dow Jones industrials closing off nearly 1.8 percent. Treasury debt prices also fell while the dollar eased against the euro and the yen.

U.S. short-term interest rate futures expect no imminent change from the Fed, but point to rate increases in the final months of the year.

SLOW RECOVERY

The minutes showed a Fed increasingly concerned about inflation and anticipating sluggish growth for a while, but cautiously optimistic the worst of the most serious financial crisis in years has passed.

"Much of the concern about severe disruptions to financial markets, which had motivated the aggressive policy actions at the beginning of the year, appears to have abated in the minds of most members," said Lehman Brothers economist Michael Hanson.

Given recent shocks to the economy, it could be years before growth rates and unemployment levels return to their optimal levels, the Fed said.

The interest rate cut on April 30 was the seventh in a series of that has taken the interbank lending rate down by 3.25 percentage points since September as the central bank moved to buffer an economy battered by the housing downturn and a credit crunch.

The economy has expanded at a sluggish 0.6 percent annual rate in both the last three months of 2007 and the first quarter of this year.

At the same time, however, record high oil prices have pushed up energy and food prices, raising the consumer price index by 3.9 percent in the 12 months to April.

Policy-makers felt at their April meeting that the risks that growth could slow were more closely balanced than in the past by the risks that inflation could spike higher.

"Members were ... concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and the fact that some indicators suggested that inflation expectations had risen in recent months," the Fed said.

DIFFERENCES OVER INFLATION RISK

Participants at the Fed's meeting were about evenly divided as to whether the risks to the inflation outlook were balanced or were tilted to the upside, the minutes said.

The Fed boosted its forecasts for inflation to 3.1 percent to 3.4 percent in 2008 from its January 2.1 percent to 2.4 percent projection for the personal consumption expenditures index. It expects unemployment to rise to 5.5 percent to 5.7 percent for the year. The jobless rate was at 5 percent in March and employers had cut jobs for the fourth month in a row.

The Fed also warned that the risks to its scaled-down growth projection remain to the downside, particularly if house prices continue to slide lower.

"Participants saw little indication of a bottoming out in either housing activity or prices," the minutes of the meeting said.

Fed officials took some comfort from signs that fragile credit markets, which have been severely shaken by doubts about bad credit, appear to be on the mend.

"The generally better state of financial markets had caused participants to mark down the odds that economic activity could be severely disrupted by a further substantial deterioration in the financial environment," the minutes said.

Photo: Reuters