May 22 (Bloomberg) -- Federal Reserve policy makers signaled that an economic contraction in the first half won't be enough to spur further interest-rate cuts because of a rising threat from inflation.

Minutes of the Federal Open Market Committee's April 29-30 meeting, released yesterday in Washington, showed many officials foresaw a contraction from January to June. At the same time, they raised their consumer-price estimates and said risks are more closely balanced between weaker growth and faster inflation.

``They will be patient,'' said Vincent Reinhart, former head of the Fed's monetary-affairs division and now a scholar at the American Enterprise Institute in Washington. ``They are signaling that they will probably control the inflation risk by keeping the federal funds rate tighter than usual in 2009.''

The report indicated Chairman Ben S. Bernanke and his colleagues are increasingly concerned by public expectations for inflation that climbed to a 12-year high this month. Traders anticipate the Fed will keep its benchmark rate unchanged next month and raise it by year-end.

The April 30 decision to lower the main rate by a quarter point, to 2 percent, was a ``close call'' for most FOMC members, the minutes said. The reduction capped off 2.25 percentage points of reductions this year, including cuts of 0.75 point in January and in March.

Weaker Growth

Policy makers updated economic forecasts at the meeting, estimating U.S. gross domestic product will increase by 0.3 percent to 1.2 percent this year, down from the 1.3 percent to 2 percent pace they foresaw in January.

Consumer prices, minus food and energy costs, are projected to rise by 2.2 percent to 2.4 percent, up from a range of 2 percent to 2.2 percent in the last forecast.

Stocks tumbled yesterday after the report. The Standard & Poor's 500 Index dropped 22.69, or 1.6 percent, to 1390.71. Equity futures were little changed today. Treasury prices fell, raising yields on benchmark 10-year notes to 3.81 percent from 3.78 percent. Yields were at 3.87 percent today.

Yesterday's report may have raised investor concerns about stagflation, the combination of stagnant growth and high inflation seen in the 1970s, said Keith Hembre, chief economist at Minneapolis-based FAF Advisors Inc., which oversees $113 billion in assets.

``When you've got growth slowing and inflation going up, that's about the worst combination for the markets you can have,'' said Hembre, a former researcher at the Minneapolis Fed.

Volcker Warning

Former Fed Chairman Paul Volcker warned last week that ``there is some resemblance to where we are now in the inflation picture to the early 1970s.'' The central bank failed to contain a pickup in prices at the time, spurring the acceleration later that decade, he said at a congressional hearing.

Two district-bank presidents dissented from the April rate cut, while Fed Governor Kevin Warsh said in a Washington speech yesterday that central bankers should be ``inclined to resist'' calls for further moves ``even if the economy were to weaken somewhat further.''

In their April 30 statement, officials dropped previous language referring to ``downside'' risks to economic growth remaining even after lowering rates.

``The committee felt that it was no longer appropriate for the statement to emphasize the downside risks to growth,'' the minutes said yesterday. Officials judged that the risk of another round of financial disruptions hobbling the economy had ``receded'' since their March meeting.

Lowest Since 1980

Policy makers lowered their growth projections after economic figures showed a continued decline in housing and a slump in consumer confidence to the weakest level since 1980. Employers have also cut payrolls for four consecutive months.

``Growth in consumer spending appeared to have slowed to a crawl in recent months and consumer sentiment had fallen sharply,'' the minutes said. ``The outlook for business spending remained decidedly downbeat.''

A report today showed that fewer Americans than forecast applied for unemployment benefits last week, indicating companies are reluctant to fire more workers even as the economy slows. First-time jobless claims fell 9,000 from the prior week, to 365,000, the Labor Department said.

Construction of U.S. single-family houses in April dropped to the lowest level in 17 years, the Commerce Department said last week. Residential investment, a component of gross domestic product, has declined for nine consecutive quarters.

Oil Surge

Fed officials are also contending with a surge in oil prices that has both depressed confidence and spending on other items and pushed up inflation. Crude oil surpassed $134 a barrel yesterday for the first time and has climbed about 39 percent this year.

Policy makers anticipated some pickup in the economy later this year as $117 billion in government tax rebates takes effect.

That's another reason ``not to do anything'' with interest rates, said David Wyss, chief economist at Standard & Poor's in New York.

While Fed officials increased their projections for the jobless rate and inflation in 2009, they kept GDP growth forecasts little changed.

The median range of economic-growth projections for next year was 2.0 percent to 2.8 percent. The jobless rate was seen at 5.2 percent to 5.7 percent. The rate was 5 percent last month.

Inflation projections, based on the Commerce Department's personal consumption expenditures price index, rose about a quarter percentage point for 2009 and were little changed for 2010.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: May 22, 2008 09:20 EDT