Tunbull, I think that when Fredo and Michael have a drink in Havana, Michael is carefully feeling him out. I think that there may have been some doubts about Fredo, but I don't think that Michael truly suspected him. He may have thought that Fredo inadvertently gave something away, but given his reaction to Fredo's Johnny Ola comment during the Superman show, I agree that the revelation hit Michael very, very hard.

And yes, I do believe that he was thinking of giving Fredo a pass. Perhaps he would ostracize him, but I don't think he considered killing his brother, until that day in the boathouse. When Fredo revealed his resentment and anger at his father and brother for what he perceived as a lack of faith in his abilities, when Michael understood the EXTENT of Fredo's anger during his vitriolic rambling, then Michael knew that Fredo would be a danger to his Family, and therefore his family. He knew that he couldn't afford to let Fredo live.

What I did find interesting was Fredo's inability to be angry with his father. I believe that all three of Vito's sons adored their father and couldn't bring themselves to go against him, even after his death. Michael changed his destiny (or fulfilled his destiny, depending on how you look at it) our of love for his father. Fredo, who felt he was passed over in favor of his brother, was so angry at Vito for doing it, that he betrayed the family. And yet they never, ever criticized their father.