Fed pushes back recovery forecast

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NEW YORK (CNNMoney.com) -- Federal Reserve policymakers lowered their economic outlook for the rest of the year at its meeting last month, suggesting that they may not be done taking unprecedented steps to try and jumpstart a recovery.

According to the minutes of the Fed's latest policy meeting, which were released Wednesday, the central bank said that gross domestic product, the broadest measure of economic activity, is likely to flatten out in the second half of 2009 and expand only slowly next year.

The Fed also said that it now expected the unemployment rate to rise more steeply into early next year before "flattening out at a high level over the rest of the year." The unemployment rate hit 8.5% nationwide in March, up from 8.1% a month earlier.

The Fed had previously forecast in January that GDP would start to recover in the second half of this year and that the economy would grow between 2.5% and 3.3% in 2010. The central bank had also projected in January that unemployment would peak at 8.5% to 8.8% this year and fall to a range of 8% to 8.3% in 2010.

The minutes showed that some policymakers were more optimistic, stating that they "believed that the natural resilience of market forces" would still lead to a recovery in 2009. But other members "saw recovery as delayed and potentially weak."

The minutes also showed that policymakers were split as to how much worse the economy would get and what the Fed should do about it.

Some Fed members voiced fears of deflation, a broad-based drop in prices that can wreak havoc on the economy. Several policymakers wanted the Fed to pump up the economy by buying long-term Treasury notes, while others thought it would be better to purchase mortgage-backed securities.

In the end, the central bank took both steps. It agreed to buy up to $300 billion of longer-term Treasury notes over the next six months, and also announced plans to buy an additional $750 billion in mortgage-backed securities.

The Fed also kept its key fed funds rate near zero, and reiterated that it expected the rates to stay "exceptionally low for an extended period." And according to the minutes, Fed members were not concerned about any inflation pressures in the foreseeable future.

The Treasury and mortgage purchases helped bring down interest rates, including mortgage rates, and helped feed a rally in U.S. stocks.

Many market analysts believe the rally has been fueled by the growing hope that an economic recovery may be on the horizon. Some reports have indicated that there could be signs of stabilization in the battered housing and retail sectors.

Sung Won Sohn, professor of economics at Cal State University Channel Islands, said he believes the Fed's outlook was probably too bullish heading into the March meeting and that the lowered forecast is more in line with the consensus expectations of economists.

But Sohn said the Fed is likely to have a more optimistic view about the economy at its next meeting at the end of this month, given some of the recent economic readings that have suggested a bottom could soon be near.

"In March, they were essentially looking at January and February economic numbers, which will hopefully turn out to be the worst of this economic cycle," said Sohn. "I think they'll continue to be cautious in April, but I think the tone of the language of the next minutes will show an improved perception of the economy."

Stocks, which had been higher in early-afternoon trading Wednesday, pulled back following the release of the Fed minutes and were trading modestly lower.