Special report:
Eyes on the Fed Full coverage
Fed holds rates steady
Key rate unchanged at 5.25 percent but with the economy slowing and inflation looming, what's the central bank's next move?
By Paul R. La Monica, CNNMoney.com editor at large

NEW YORK (CNNMoney.com) -- The Fed held interest rates steady Wednesday and noted again that the economy was slowing, but the central bank also indicated it's still wary of inflation - a sign the Fed may not cut rates in coming months as many investors had hoped.

Federal Reserve policy-makers held their target for the federal funds rate, an overnight bank lending rate that helps determine the interest consumers pay on auto and other loans, at 5.25 percent.

Click here
Is the Fed right to be holding rates steady now?
  No, they should be cutting
  No, they should be raising
  Too early to say
or View results

The move, widely expected on Wall Street, marked the third straight time the Fed left rates alone after raising them 17 consecutive times through June. But now many economists and market strategists think Fed Chairman Ben Bernanke & Co. face tougher decisions ahead.

Some argue the Fed should consider rate cuts next year in a bid to make sure the economy doesn't tumble into recession. Others who fear inflation is a more pressing threat say the Fed should start raising short-term rates again.

Again, there was dissension within the Fed on the matter after the two-day meeting that ended Wednesday.

For the third consecutive meeting, Federal Reserve Bank of Richmond President Jeffrey Lacker voted against a pause and for a quarter-point rate hike. The other 10 members of the Fed's policy-making committee voted to leave rates unchanged.

Despite Lacker's continued support of a rate hike, some think it's highly unlikely the Fed will raise rates anytime soon.

"The housing market is undeniably slowing. And even with oil prices coming down there really are headwinds facing the economy. It's tough to believe that the next move will be a rate hike," said Vincent Boberski, portfolio strategist with FTN Financial in Memphis.

The Fed did, however, appear to indicate it may be more worried about a slowdown. In its statement, the Fed said "economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market."

That differs slightly from the language on the economy in the last statement when the central bank said that "moderation in economic growth appears to be continuing."

But the Fed added that the economy "seems likely to expand at a moderate pace" going forward.

It also kept its language about the threat of inflation, saying that "readings on core inflation have been elevated" and that "some inflation risks remain." The Fed did remove a phrase about energy prices and other commodity prices having "the potential to sustain inflation pressures."

David Kelly, an economic advisor at Putnam Investments in Boston, said the changes to the statement show the Fed is fairly satisfied with the prospects for economic growth next year as well as the inflation picture.

"This statement is an expression of increased confidence in the economic outlook," Kelly said.

As such, Kelly said he thinks the Fed will probably start cutting rates sometime in 2007. He does not expect the Fed to change rates at its next meeting in December, however.

Michael Cheah, a portfolio manager who runs two bond funds for AIG SunAmerica Asset Management, also said the Fed will probably lower rates in 2007.

"The Fed appears to be putting the economy ahead of inflation. It is trying to assure the market that inflation is under control. In terms of the next move, I am confident enough to predict the next move will be a cut," he said.

Cheah added that even though the Fed still expressed concern about inflation, he argued that oil prices would need to surpass the record highs hit last summer before the Fed would need to be seriously concerned about inflation.

And since the housing market keeps showing signs of weakness - a report from the National Association of Realtors Wednesday showed home prices posted a record drop from a year earlier in September - Cheah said a rate increase is probably the last thing the Fed wants to consider now.

"Another rate hike would absolutely destroy the housing market. That would be unthinkable," he said.

But some think the Fed will be in no hurry to cut rates and that once it does, it may not cut them dramatically since the economy appears to be in reasonably healthy shape.

"For the foreseeable future rates are going to be unchanged," said Keith Stock, president of MasterCard Advisors, the consulting and services arm of credit card firm MasterCard (Charts).

Traders appear to share that view. According to federal funds futures contracts on the Chicago Board of Trade, contracts set to expire next June show traders betting on a 5.215 percent rate, implying the Fed may not cut or at best cut once between now and the middle of next year.

Stock prices were mixed after the Fed statement with the Dow little changed and the S&P 500 and Nasdaq inching higher. Bonds rallied, pushing the yield on the 10-year Treasury note down to 4.76 percent, as investors bet lower rates are coming. Bond prices and yields move in opposite directions.

Beware: More rate hikes may be coming

How the Fed affects your wallet

More on the Fed and rates Top of page

Follow the news that matters to you. Create your own alert to be notified on topics you're interested in.

Or, visit Popular Alerts for suggestions.
Manage alerts | What is this?