May 11 (Bloomberg) -- The Obama administration projected that the U.S. economy will expand at a 3.5 percent annual rate by year-end, a rebound that would be almost twice as strong as private forecasters expect.

In the economic assumptions of its 2010 budget request, President Barack Obama’s economic team didn’t change its 2009 predictions for a 1.2 percent drop in gross domestic product this year, slower inflation, higher unemployment and lower market interest rates than a year ago.

As early as the end of this year, GDP may rise at a 3.5 percent annual rate, the same pace projected for all of next year, helped by a $787 billion stimulus package, the administration said in the report today. That’s more optimistic than the 1.8 percent fourth-quarter growth estimate in the monthly Blue Chip Economic Indicators survey released May 10.

“Although the economic downturn so far in 2009 has been more severe than the administration expected when the forecast was finalized, if the financial system begins to function more normally, there is every reason to expect a somewhat stronger recovery given the depth of the current recession,” the White House said today.

The administration expects “housing starts to reach bottom this year and to begin a robust recovery as relative housing prices stabilize,” today’s report said.

The Federal Reserve’s “novel” policies of extending funds to banks to boost liquidity and purchasing short- and long-term Treasuries also will help underpin the recovery, the White House said. Still, a doubling of the Fed’s balance sheet to about $2 trillion “holds the potential for an explosive increase in the nation’s money supply,” it said.

“So far that has not occurred, because much of the increase in Federal Reserve liabilities has gone into idle reserves of the banks,” the administration said. The central bank “is prepared to reduce the assets on its balance sheet promptly as the economy recovers from the current recession and the crisis in the financial sector eases.”

The report also said “inflation is expected to remain subdued over the next few years.”

To contact the reporters on this story: Brendan Murray in Washington at brmurraybloomberg.net;

Last Updated: May 11, 2009 09:31 EDT