April 9 (Bloomberg) -- Federal Reserve officials signaled they will slow the pace of interest-rate cuts even as they concluded ``some contraction in economic activity'' is likely.

Some Federal Open Market Committee members saw the danger of a ``prolonged and severe downturn,'' according to minutes of its March 18 meeting released yesterday. Still, ``monetary policy alone could not address fully the underlying problems in the housing and financial markets,'' the minutes said.

``It holds out the prospect that the committee will continue to be cautious going forward, and rather than dropping a half- point would be more inclined to drop a quarter-point,'' J. Alfred Broaddus Jr., former president of the Richmond Fed, said in a Bloomberg Television interview.

Policy makers cut the benchmark lending rate 2 percentage points in the first 11 weeks of the year, the fastest pace in two decades. They may now need to assess the impact of the reductions, $168 billion of fiscal stimulus, and several steps to increase liquidity in financial markets.

The Fed's target rate for overnight loans between banks is 2.25 percent, down from 5.25 percent in September. Economists anticipate officials will stop lowering borrowing costs after cutting the rate to 1.75 percent in June, according to the median of 62 estimates in a Bloomberg News monthly survey published today.

`Very Reluctant'

``The most important factor is, I think, they know that the fiscal stimulus is about to go out,'' said Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York, referring to tax rebate checks scheduled for distribution from May. Fed policy makers ``are very reluctant to go below 1 percent. And they're pretty reluctant to go below 2.''

Fed Chairman Ben S. Bernanke has overseen an expansion of the Fed's efforts to alleviate the credit crunch that has gone beyond rate cuts, including making loans directly to investment banks. Officials are seeking to limit the impact on the broader economy of what former Fed chief Alan Greenspan yesterday termed the worst credit crisis in 50 years.

The central bank also made an emergency loan to Bear Stearns Cos. and agreed to take on $30 billion of the firm's assets to secure its takeover by JPMorgan Chase & Co. Yesterday's minutes included no details on the discussions surrounding the decision, which was made by the Fed's Board of Governors, rather than the FOMC.

Bernanke and New York Fed President Timothy Geithner faced congressional scrutiny over the Bear Stearns transaction at a Senate Banking Committee hearing last week.

`The Very Edge'

The deal took the Fed ``to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles,'' Paul Volcker, chairman of the Fed from 1979 to 1987, told the Economic Club of New York yesterday.

Fed and U.S. Treasury officials are considering ways to replenish the central bank's supply of government bonds if needed to ensure the Fed can keep lending to Wall Street dealers.

One of the main contingency plans under discussion would be for the government to sell more debt and deposit the proceeds with the Fed, according to a Treasury official and two people at the central bank familiar with the proposal. The Fed would then use the cash to purchase Treasury notes, which it could lend on to investment banks. The Wall Street Journal reported on the plans earlier today.

Separately, the New York Fed said it will auction $50 billion of U.S. Treasuries tomorrow, the third sale under the $200 billion Term Securities Lending Facility.

Contraction

Fed staff economists told policy makers they had ``substantially revised down'' their forecast to show a first- half contraction in gross domestic product, with a ``slow rise'' in the second half. In 2009, the staff projected growth ``somewhat above'' the economy's long-term potential pace, the minutes showed.

Some stabilization in U.S. housing markets is probably needed to ``underpin'' the economy's recovery, though policy makers saw ``little indication'' that the process had begun, the minutes said.

The number of Americans signing contracts to buy previously owned homes fell more than forecast in February, a report showed yesterday, indicating no sign of a bottom in the real-estate recession that is entering its third year. The National Association of Realtors' index of signed purchase agreements dropped to 84.6, the lowest level since records began in 2001.

The economy won't expand at all in the first six months of the year, according to the median estimate in Bloomberg's monthly survey of economists, conducted April 2 to April 8.

Moderate

Futures trading shows investors anticipate a quarter-point cut in the federal funds rate target at the April 29-30 meeting, to 2 percent.

Policy makers continued to express concern about rising consumer prices, though ``most participants still expected inflation to moderate later this year and in 2009,'' the minutes said. Fed staff economists also projected inflation would slow next year.

The Fed's preferred inflation measure, the personal consumption expenditures price index minus food and energy, rose 2 percent in February from 12 months before. Including the two items, prices climbed 3.4 percent, the fourth straight month in excess of 3 percent.

Committee members last month also discussed evidence of an ``adverse feedback loop,'' where lenders reduce credit, hurting growth and causing lending to contract further, the minutes showed.

``Several participants noted that the problems of declining asset values, credit losses, and strained financial market conditions could be quite persistent, restraining credit availability and thus economic activity,'' the minutes said.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.

Last Updated: April 9, 2008 14:59 EDT