Fed's economic forecast worsens

NEW YORK (CNNMoney.com) -- The Federal Reserve's latest forecasts for the U.S. economy are gloomier than the ones released three months earlier, with an expectation for higher unemployment and a steeper drop in economic activity.

The Fed's forecasts, released as part of the minutes from its April meeting, show that its staff now expects the unemployment rate to rise to between 9.2% and 9.6% this year. The central bank had forecast in January that the jobless rate would be in a range of 8.5% to 8.8%, but the unemployment rate topped that in April, hitting 8.9%.

The Fed also now expects the gross domestic product, the broadest measure of the nation's economic activity, to post a drop of between 1.3% and 2% this year. It had previously expected only a 0.5% to 1.3% decline.

At the April meeting, the Fed decided to once again leave its key federal funds rate near 0%, a level it has been at since last December. The central bank also announced that it did not plan on increasing purchasing more long-term Treasury notes anytime soon.

The Fed disclosed plans to begin buying $300 billion's worth of such Treasurys in March in order to try and keep long-term rates down and boost economic activity.

But according to the minutes, some members of the central bank's policy committee indicated they were open to increasing its purchases of Treasury notes and mortgage securities as a way of spurring more lending.

Treasury prices rallied after the minutes were released, pushing their yield, which moves in the opposite direction, down to 3.18%.

Stocks, which have moved sharply higher during the past two months on hopes that the recession may soon be ending, fell Wednesday afternoon.

According to the minutes, Fed members did indicate they expected GDP to increase slightly in the second half of this year. However, it would not be enough to overcome the anticipated declines in the first half. GDP shrunk more than 6% in the first quarter.

Policymakers acknowledged that there were some better economic readings in the period leading up to the April meeting, but added that they were not convinced the economy was out of the woods yet.

In the minutes, Fed members indicated that there are a number of factors that "would be likely to restrain the pace of economic recovery over the medium term" and added that the credit crunch would "recede only gradually" and that "households would likely remain cautious" in their spending.

Fed members expressed concerns about rising problems in the commercial real estate market as well, indicating that this could cause further problems for financial institutions still struggling with the effects of the collapse of home prices and rising mortgage defaults.

The Fed also reduced its GDP targets for 2010 and 2011, but the central banks still expects the economy to grow in both years.

Rich Yamarone, director of economic research at Argus Research, said that the Fed's new forecasts were "more of a reality check than a revision," given the deterioration in the labor market and overall economy since January.

But he and other economists said it also appeared from the minutes that the Fed is pleased with how the economy has started to respond to the steps it has taken, including the purchases of mortgages and Treasurys.

"I read [the minutes] as 'We think it's working, let's wait a few months to see how it plays out,'" said Gus Faucher - director of macroeconomics at Moody's Economy.com. He added that it did not seem like the Fed felt a "sense of urgency" to increase the scope of its Treasury purchase program.

And Yamarone said it's important to remember that the forecasts and minutes are three weeks old, and that economic readings since the meeting, including home sales and the rate of job losses, have generally showed signs of improvement.

"These minutes look like they have a bleaker assessment, but things were darker then," he said. "I can't say it's an accurate interpretation of their outlook today. I think that would be a little more favorable."