The Federal Reserve slashed its forecast for the growth of the American economy last night, as it took account of tightening mortgage and housing markets and rising oil prices.

The Dow Jones industrial average fell in early trading – although it closed up last night, above the 13,000-point watershed – and the euro reached a fresh high against the dollar after the minutes of the Fed’s October meeting showed that the US central bank predicted that growth next year would be between 1.8 per cent and 2.5 per cent, sharply down from a 2.5 per cent to 2.75 per cent range forecast in June.

Confidence was also knocked by Freddie Mac, America’s second-biggest provider of mortgage financing, announcing its largest quarterly loss on the back of $4.8 billion of bad debts and writedowns in the third quarter.

However, traders on Wall Street later took heart from the remarks, interpreting them as a suggestion of further cuts in US interest rates. At the close, the Dow was up 51.70 points at 13,010.10.

Despite the risk of a sharper slowdown, the Federal Open Markets Committee said that its vote for a quarter-point cut in interest rates had been close.

“Most members saw substantial downside risks to the economic outlook and judged that a rate reduction at this meeting would provide valuable additional insurance against an unexpectedly severe weakening in economic activity,” the minutes read.

With energy prices rising, Fed members said that they wanted to “underscore” the risk of inflation. One member of the 12-strong committee voted against the cut in rates, preferring to leave policy unchanged.

Analysts said that the minutes did not rule out further cuts in rates if conditions continued to deteriorate.

The minutes also revealed for the first time that the Fed is working towards an unofficial inflation target of 1.5 to 2 per cent, as measured on the so-called personal consumption expenditures (PCE) price index.

That is where Fed members forecast that inflation would stand by 2010.

Ben Bernanke, the Fed Chairman, said last week that the central bank would start producing quarterly economic forecasts spanning three years, in an attempt to provide a clear idea of what inflation level the Fed wants its decisions to deliver.

Overall inflation should stabilise next year to between 1.8 per cent per cent and 2.1 per cent, the Fed added, assuming that energy prices flattened out.

Core inflation is 1.8 per cent.

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