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Originally published Thursday, May 22, 2008 at 12:00 AM

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Fed's outlook weak as energy costs zoom

Federal Reserve officials strongly suggested they won't be inclined to cut interest rates further even as they sharply downgraded their...

The Associated Press

WASHINGTON — Federal Reserve officials strongly suggested they won't be inclined to cut interest rates further even as they sharply downgraded their forecast for economic growth this year, citing damage from a housing slump, credit crunch and galloping energy prices.

Investors reacted to the weaker outlook and the possibility that the Fed's rate-cutting campaign was over by sending the Dow Jones industrials down more than 200 points.

In fact, the Fed's decision to lower interest rates at its April 29-30 meeting was a "close call," according to minutes of those private deliberations released Wednesday.

The Fed hopes that its series of powerful rate cuts ordered since last September and the government's $168 billion stimulus package of tax rebates for people and tax breaks for businesses will help energize growth somewhat in the second half of this year.

Fed officials viewed economic activity "as likely to be particularly weak in the first half of 2008; some rebound was anticipated in the second half of this year," the documents stated.

The Fed also forecast higher unemployment and inflation for this year.

Given the hope of a second-half economic pickup but worried about inflation, Fed officials signaled last month that their one-quarter-point rate reduction, which dropped their key rate to 2 percent, might be their last rate cut for some time.

"Most members viewed the decision to reduce interest rates at this meeting as a close call," the documents showed. "Although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices."

Many economists believe the Fed will hold its key rate steady when it meets next, on June 24-25.

That sentiment was borne out in the Fed's documents as well as recent speeches by Fed officials.

Looking ahead, some Fed members — not identified in the documents — 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, unless economic and financial developments indicated a significant weakening in the economic outlook," according to the Fed papers.

Separately, Fed Governor Kevin Warsh, in remarks Wednesday, also suggested the Fed was not inclined to cut rates again. "Even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again," Warsh said.

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Under its new projections, the Fed now believes gross domestic product will grow from just 0.3 percent to 1.2 percent this year. That's lower than a previous Fed forecast, released in late February, that estimated growth to be between 1.3 and 2 percent.

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.

These forecasts are based on what the Fed calls its "central tendencies," which exclude the highest three forecasts and the lowest three forecasts made by Fed officials. The Fed also gives a range of all forecasts that showed some Fed officials projecting no growth in 2008.

With economic growth slowing, the Fed projected that the national unemployment rate will rise to between 5.5 and 5.7 percent this year. That is higher than the central bank's old forecast for the rate to climb as high as 5.3 percent. Last year, the unemployment rate averaged 4.6 percent.

And, with energy prices marching upward, the Fed raised its projection for inflation. The Fed now expects inflation to be between 3.1 and 3.4 percent this year. That's higher than its old forecast for inflation, which was estimated to come in at around 2.1 percent to 2.4 percent.

Oil prices on Wednesday blew past $130 a barrel for the first time. Gasoline prices moved closer to $4 a gallon.

At the Fed meeting last month, two members — Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and Richard Fisher, president of the Federal Reserve Bank of Dallas — opposed cutting rates, a crack in the usually unified front the Fed often shows the public.

Both men have a reputation for being especially vigilant about fighting inflation. And, some fear that further rate cuts could aggravate inflation.

Against this backdrop, Brian Bethune, an economist at Global Insight, predicted:

The Fed "is therefore expected to be on hold for the time being, even if the economy showed signs of slowing further, or even contracting in the short term."

Copyright © 2008 The Seattle Times Company

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