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Fed sees hopeful signs but downgrades `09 forecast

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WASHINGTON — The Federal Reserve expects the economy to improve in coming months, even as policymakers downgraded their outlook for all of 2009 and said the unemployment rate could approach 10 percent.

Fed Chairman Ben Bernanke and his colleagues continue to believe that business sales and factory production will begin to recover gradually during the second half of this year as President Barack Obama's stimulus package and the Fed's aggressive efforts to lift the country out of recession take hold. They also pointed to signs that the recession's grip was easing in the current quarter, according to documents released Wednesday.

At the Fed's last meeting on April 28-29, policymakers opted not to take any new steps to shore up the economy after launching a $1.2 trillion effort in March. But some members last month said those plans for buying government debt and mortgage securities may need to be expanded to speed a recovery.

"Participants noted some improvement in financial conditions in recent months, signs that consumer spending was leveling out and tentative indications that activity in the housing sector might be nearing its bottom," the documents said.

That's consistent with observations made earlier this month by Bernanke, who gave his most optimistic prediction about the end of the recession, saying he expected the economy to begin growing again later this year.

In fact, the Fed's staff bumped up its forecast for economic growth for the second half of this year, although a figure wasn't provided.

Even with those positive signals, the economy's performance for this year as a whole is expected to be dismal, partly reflecting the 6.1 percent annualized drop in economic activity in the first quarter.

Under the Fed's new projections, the economy will shrink this year between 1.3 and 2 percent. The old forecast said the economy could contract between 0.5 and 1.3 percent.

The unemployment rate may rise as high as 9.6 percent, higher than the old forecast of 8.8 percent. The jobless rate bolted to 8.9 percent in April, the highest in a quarter-century.

The predictions are based on what the Fed calls its "central tendency," which exclude the three highest and three lowest forecasts made by Fed officials. The Fed also gives a range of all the forecasts that showed some officials expect the jobless rate to hit 10 percent this year.

To revive the economy, the Fed has cut its key interest rate to a record low near zero and is expected to hold it there well into next year. The Fed also has turned to unconventional tools to lower interest rates and spur spending, which would help bolster economic activity.

All members agreed with "waiting to see how the economy and financial conditions respond to the policy actions already in train," according to separate minutes of the April meeting. However, they held the door open to additional action if needed.

The Fed at its meeting in March launched a bold $1.2 trillion economic-revival effort. It agreed to starting buying up to $300 billion worth of government debt over the next six months and to boost purchases of mortgage securities and debt from Fannie Mae and Freddie Mac.

At the April meeting, some Fed policymakers said additional purchases "might well be warranted at some point to spur a more rapid pace of recovery."

The Fed has been battling the worst financial crisis since the 1930s, which has plunged the country into the longest recession since War World II.

With all the shocks to the economy, its recovery will be gradual. That will keep unemployment elevated well into 2011 and it could take time for the economy to get back to a path of full health in the longer term, the Fed documents said. Most Fed policymakers indicated that they expected "the economy to take five or six years" for that to happen, but their estimates for growth over the next few years are more optimistic.

The Fed expects the economy to grow next year between 2 and 3 percent. It should then pick up more speed in 2011, growing between 3.5 and 4.8 percent, according to the "central tendency" projections. The unemployment rate should drop to between 9 and 9.5 percent next year. It should dip to between 7.7 and 8.5 percent in 2011.

Private economists consider an unemployment rate around 5 percent to be normal. Some private economists don't believe that will happen until 2013 and questioned the rosier overall outlook for next year.

The Fed projected "very low" inflation for this year, with prices rising only between 0.6 and 0.9 percent. With a gradual recovery expected, prices should only inch up in 2010 and 2011.

On another matter, the Fed policymakers continued to resist calls from lawmakers on Capitol Hill to reveal the identities of banks and other financial institutions that draw emergency loans and participate in other Fed credit programs. Fed policymakers said such disclosure would be viewed "as a sign of financial weakness" and that the "resulting stigma would undermine the effectiveness" of the programs, which are intended to promote financial stability and economic recovery.