Fed Remains On Hold Despite Jitters in Financial Markets

The Federal Reserve left a key interest rate unchanged on Tuesday as worries about inflation trumped concerns about turbulent financial markets.

Fed Chairman Ben Bernanke and his colleagues voted unanimously to keep their target for the federal funds rate, the interest that banks charge each other, at 5.25%, where it has been for more than a year.

The Fed decision came after a volatile couple of weeks on Wall Street as investors have been beset by troubles in global credit markets stemming from a sharp rise in defaults on subprime mortgages.

In a brief statement, the Fed acknowledged the turbulence and said the downside risks to the economy had "increased somewhat."

But the Fed continued to state that the predominant risk remained that inflation "will fail to moderate as expected."

Many analysts believe the Fed will remain on hold through the rest of this year, preferring to watch and make sure that inflation moderates back to an acceptable level.

The Fed's statement was a disappointment to Wall Street, where investors had held out the hope that the ongoing problems in credit markets would prompt the Fed to send a signal that it was prepared to ease rates later this year if conditions worsened. In the first half hour of trading after the mid-afternoon announcement, the Dow Jones industrial average fell by 90 points.

Tuesday marked the ninth consecutive meeting where the Fed has left its key policy lever unchanged. The last rate move was a quarter-point increase, the 17th in a row, on June 29, 2006. That capped a two-year campaign that pushed the funds rate from a 46-year low of 1% to its current level in a bid to slow the economy enough to keep inflation under control.

The decision to leave rates unchanged means that banks' prime lending rate, the benchmark for millions of consumer and business loans, will remain where it has been for the past year at 8.25%.

As it did at its June meeting, the central bank said that the readings on core inflation have improved modestly in recent months.

A key inflation gauge watched closely by the Fed which excludes food and energy was up 1.9% over the 12 months ending in June, putting it back within what is widely perceived as the Fed's comfort zone of 1% to 2%.

On the overall economy, the Fed noted the recent problems.

"Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing," the statement said.

But with all of these problems, the Fed repeated its belief from past statements that "the economy seems likely to continue to expand at a moderate pace over coming quarters." The statement said the U.S. economy would be supported by solid growth in employment and a "robust global economy."

The overall economy, after having slowed to a barely discernible growth rate of 0.6% in the first three months of this year, grew at a solid annual rate of 3.4% in the April-June period even though the slumping housing market continued to subtract from growth.

Economists expect continued troubles in housing and spreading problems with subprime mortgages and other loans acting to slow growth to a more moderate pace of around 2.5% in the final half of this year.

Growth at that pace would not be fast enough to keep the unemployment rate from rising. The government announced last week that the jobless rate in June rose to 4.6%, the highest level in six months, and many economists believe it will end the year up around 5 percent. That would still be relatively low by historical standards.