The Federal Reserve expects the economy this year will sink at a slower pace than it previously thought, but that unemployment will top 10 percent, according to a forecast contained in the latest Fed minutes.
The Fed now predicts the economy will shrink between 1 and 1.5 percent this year, an improvement from its old forecast issued in May. At that time, the Fed projected the economy would contract between 1.3 and 2 percent.
The upgrade, part of the minutes from the Fed's June 23-24 policy meeting, comes from the expectation that the economy's downhill slide in the first half of 2009 wasn't as bad as previously thought.
The Fed said the economy should start growing again in the second half of this year, although the pace is likely to be plodding. The prediction added fuel to the stock market rally.
Against that backdrop, the Fed's forecast for unemployment this year worsened. The central bank predicted the jobless rate could rise as high as 10.1 percent, compared with the previous forecast of 9.6 percent.
The nation's unemployment rate climbed to 9.5 percent in June, a 26-year high.
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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 central bank also gives a range of all the forecasts. That ranged showed that some officials expect the jobless rate could rise as high as 10.5 percent this year.
Fed policy-makers opted to hold fire on additional asset purchases at their meeting last month because of doubts about how markets would react to more buying, the minutes also showed.
Although Fed officials judged that the economy remained vulnerable, they opted not to increase an already announced $1.75 trillion asset purchase program from worry this could do more harm than good.
"Although an expansion of such purchases might provide additional support to the economy, the effects of further asset purchases, especially of Treasury securities, on the economy and on inflation expectations were uncertain," according to the minutes.
Long-term bond yields had risen somewhat in the weeks before the meeting, with some blaming the change on fears among investors that the Fed would monetize the debt -- purchase U.S. government bonds with newly created money to help it finance a record budget deficit.
The Fed held interest rates unchanged in a range of zero to 0.25 percent at the meeting, and repeated an assurance that rates would remain exceptionally low for an extended period.
With rates about as low as they can go, asset purchases are now a key tool in the U.S. central bank's arsenal to stimulate growth.
But policy-makers felt they had done enough for now.
"Moreover, it seemed likely that economic activity was in the process of leveling out, and the considerable improvements in financial markets over recent months were likely to lend further support to aggregate demand," the Fed said.
—AP and Reuters contributed to this report.