Fears over a darkening outlook for America’s economy were fuelled last night by the Federal Reserve when it sharply cut its forecast for US growth for the second time in four months.

The Fed stoked anxieties over US prospects with a prediction that America is set to be blighted this year by a combination of anaemic growth, higher inflation and rising unemployment. Moreover, it sounded a warning that because of “downside risks”, the eventual outcome could be worse still.

The grim assessment from the central bank came amid worries that it may be hampered in its scope to make further, steep cuts in interest rates to shore-up faltering growth, as figures showed inflation in the United States gathering steam last month.

Last night’s pessimistic Fed forecasts blamed the double blows of the still-deepening slump in America’s housing market and the credit squeeze for the latest downgrade of the economy’s expected performance.

The Fed said that it now sees the US economy as likely to expand by between only 1.3 and 2 per cent this year, down by half a percentage point from its November forecast for growth of 1.8 to 2.5 per cent. The November projection had already marked a cut by 0.75 points from projections made earlier last year. America’s unemployment rate is also tipped to climb as high as 5.3 per cent, markedly above the central bank’s former view that unemployment levels would reach no more than 4.9 per cent.

However, hopes that the Fed will be able to act to stave off an even sharper slide into recession were dented when it forecast persistent price pressures, on the same day that January data showed accelerating inflation.

After oil prices this week again breached $100 a barrel, the Fed said that higher energy prices would leave US inflation at between 2.1 and 2.4 per cent this year, 0.3 points higher than its previous view. Significantly, the Fed’s preferred “core” inflation measure, excluding energy and food costs, is also now projected to be between 2.0 and 2.2 per cent this year — above the 2 per cent ceiling of its “comfort zone”. January figures showed the measure of “core” inflation at a ten-month high of 2.5 per cent.

The increased inflation forecast and yesterday’s worse than expected news over consumer price gains last month inflamed Wall Street concerns over the Fed’s ability to fend off a severe American downturn.

Amid talk that the US could succumb to a mild bout of 1970s-style “stagflation”, the quandary for the Fed over how to respond to weakening growth and rising inflation was underlined by one of its most influential senior officials. William Poole, the president of the Fed’s St Louis district and a voting member on its Federal Open Market Committee, said that too deep cuts in interest rates to avert recession could risk driving inflation to an “unacceptable” level.

“Taking out insurance against certain risks is not free,” Mr Poole said. “At any given time, policymakers could pursue a powerfully expansionary policy to all but eliminate the possibility of a significant recession . . . but doing so would come at the cost, and even likelihood, of an unacceptable increase in the rate of inflation.”

Economists on both sides of the Atlantic also sounded warnings that the bad news on the scale of persistent price pressures in the US economy could leave the Fed hamstrung in responding to the threat of a recession that some analysts believe has already begun.

Ian Shepherdson, of High Frequency Economics in New York, said the disappointing figures could mean that, after cutting rates by 1.25 percentage points last month alone, the Fed could now be forced to limit an expected further reduction on March 18 to a quarter-point, rather than the half-point move widely anticipated by the markets.

Paul Ashworth, of Capital Economics said that yesterday’s news “couldn’t have come at a worse time for the Fed”. “Persistently high inflation could take away the Fed’s flexibility to respond more aggressively to reduce borrowing costs, just at the time when it needs that flexibility the most,” he said.

The threat to US prospects confronting the powerful central bank was underlined still further yesterday by the latest evidence of the dire toll from America’s housing market slump, and the intensifying squeeze on lending conditions from the credit crunch.

Despite the Fed’s forceful action in cutting official rates, the latest data shows that a drought in lending markets is still driving up the cost of borrowing for American companies and households.

For “prime” credit-worthy homebuyers, Capital Economics reported rates for 30-year fixed-rate mortgages have now risen to 6.09 per cent, up from only 5.5 per cent a month ago, and 5.72 per cent as recently as last week. The interest rate on high-grade BAA-rated corporate debt has climbed, meanwhile, to 6.9 per cent, from 6.5 per cent a month ago.

“The credit crunch is entering a dangerous new phase, with even credit-worthy borrowers now affected,” Mr Ashworth said.

Worries over the outlook were compounded by the latest bleak housing market news, suggesting that the slump is continuing to deepen.

The number of permits issued for new residential construction in the United States dropped by a further 3 per cent in January, to an annual equivalent of 1.048 million — the lowest figure for more than 16 years.

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