Fed again leaves key rate unchanged

WASHINGTON -- The Federal Reserve left a key short-term interest rate unchanged Tuesday at 5.25%, acknowledging tighter credit conditions and growing volatility in financial markets but reiterating that inflation is the main economic threat.

A statement by the policymaking Federal Open Market Committee gave little hint the central bank would budge on interest rates soon, despite mortgage, stock and bond market turmoil that has led to tougher credit terms. It acknowledged that "downside risks to growth have increased somewhat" but still predicted modest expansion.

"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 central bank said.

"Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy," the Fed said.

The central bank noted that core inflation, a measure that excludes volatile food and energy prices, has "improved modestly." But the Fed said it needs to see sustained improvement to relax on rates. The Fed considers core readings a better gauge of underlying inflation.

Stock markets initially fell after the unanimous decision, but ended the day up modestly. The Dow Jones industrial average rose 35.52 points to 13,504.30.

Some analysts had expected the Fed to move off its focus on inflation, given credit market problems that started with rising defaults on subprime loans, higher-risk products to consumers with impaired credit. A few called the statement a step in that direction.

"The 'inflation bias' is a more nuanced or muted (statement), which is intended to signal to the markets that the (Fed) has the flexibility to respond," says Stuart Hoffman of PNC Bank.

Others say the Fed, which has held short-term rates at 5.25% since June of 2006, wouldn't cut rates unless the economy was in greater peril.

"I can leave my office and take a step toward China, but that still leaves me with quite a journey," says Richard Moody, chief economist at Mission Residential. Still, Moody expects the Fed to cut rates by the end of the year. His concern is not so much credit conditions but flagging consumer spending.