Fed holds rates steady in the face of inflation

WASHINGTON -- The Federal Reserve on Wednesday voted to hold a key interest rate at 2%, ending nearly a year of sharp rate reductions designed to boost the faltering economy. In making no change, policymakers said the odds of an economic downturn had diminished while inflation risks have risen.

Central bank officials, concluding a two-day meeting, said in their statement they expect price pressures to ease through the end of this year and into 2009. But they pointedly warned that "uncertainty about the inflation outlook remains high" because of soaring energy costs and recent data showing consumers' inflation expectations are increasing.

The Fed's policymaking Open Market Committee didn't give a clear indication what its next move would be, saying it will monitor conditions and act as needed. Fed officials next meet Aug. 5.

Dallas Fed President Richard Fisher voted against the decision, saying he would have preferred to increase rates. Fisher in recent speeches has warned that the Fed must take a more aggressive stance against surging inflation.

"The Fed will be on hold for a prolonged period due to the economic weakness, but will raise rates early next year when growth picks up," says Kurt Karl, chief U.S. Economist for Swiss Re.

Previous Fed rate cuts, recent federal tax rebates and stronger exports because of the weaker U.S. dollar should boost economic activity by late 2008 year or early 2009, Karl says.

The Fed has reduced its target for the federal funds rate — what banks charge each other for overnight loans — to 2% from 5.25% in September. The rate ifnluences rates on many business and consumer loans.

The Fed statement noted that economic activity has expanded because of consumer spending. But it also said labor markets are under "considerable stress" and noted that spiking energy prices are hurting growth at the same time they are feeding inflation pressures.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation have increased," the Open Market Committee said.