Fed leaves rates unchanged

Central bank ends nine-month course of rate cuts as it cites rising inflation risks and hints at a rebound in the economy.

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By Chris Isidore, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- The Federal Reserve left its key short-term interest rate unchanged Wednesday at 2%, marking the first time in the nine months that it did not cut rates.

The central bank also raised alarms about inflation. But experts said it is still unclear what the Fed will do with interest rates at its next meeting Aug. 5 and for the remainder of the year.

The widely expected move Wednesday comes at a time when many economists and consumers are focusing on the rising price of oil and other commodities. The central bank has a mandate to fight inflation, which it typically does by raising rates.

In fact, Dallas Federal Reserve Bank president Richard Fisher voted for a rate hike at the meeting. The other nine members of the Fed's policy-making committee were in favor of no change to interest rates.

In a statement, the Fed said it still expects inflation pressures to ease later this year, but cautioned about the upward pressure on prices caused by rising oil and other commodity prices.

In light of continued increases in those prices, the Fed said "upside risks to inflation and inflation expectations have increased."

Talking tough on inflation

Some Fed watchers said the Fed had no choice but to talk tougher about inflation.

"The Fed is talking hawkish because it's all they can do," said Rich Yamarone, director of economic research at Argus Research. "It can't cut rates due to the rising inflation environment and it can't raise rates due to the frailty of the economy and financial markets."

The central bank's statement said that the rate cuts it has already made should help lead to improved economic growth ahead, although it cautioned the economy is still weak due to tight credit, a weak housing market and high energy prices.

The fed funds rate is an overnight bank lending rate used as a benchmark to set the rates that consumers pay for many types of loans as well as the prime rate used to peg the rates paid on certain business loans.

The central bank slashed its federal funds rate seven times since last September in an effort to keep the economy from weakening significantly in the wake of the housing slowdown and credit crisis rattling Wall Street and Main Street since last summer.

Despite Fisher's push for an immediate rate hike, most economists are expecting the Fed to stay on hold until at least the end of the year, if not into 2009. And some economists say it's possible the Fed's next move might still be to cut rates further, not raise rates.

"I don't think there's anything preordained because I don't believe they know what their next move will be," said David Kelly, economist and chief market strategist for JPMorgan Funds.

Growth concerns persist

Kelly said he believes the most significant part of the statement is the Fed referring to high energy prices as a drag on the economy, as well as an inflation threat. The Fed said that "the rise in energy prices are likely to weigh on economic growth over the next few quarters." It did not say that in April.

"They clearly see the double-edged sword. That makes them less likely to raise rates than if they saw oil as an inflation threat only," he said.

Another reason the Fed might not raise rates soon is because of the weak jobs market.

Mark Vitner, senior economist with Wachovia, said the Fed has limited ability to fight inflation pressures posed by oil and commodities such as corn and wheat since their prices are largely set by global supply and demand.

But unemployment has been on the rise and wages have not been keeping up with prices. Most economists say increases in personal income, not the price of commodities, are the biggest cause for concern regarding inflation.

"They can't print oil, they can't make it stop raining in the Midwest," said Vitner. "The part of inflation the Fed can actually control is performing fairly well. We don't see any evidence of a wage-price spiral taking hold."

Lyle Gramley, a former Fed governor now with the Stanford Group, a Washington research firm, agrees that the uncertainty about growth and inflation risks make it difficult to predict what the Fed will do next.

"We just don't know how things are going to work out," he said. "The essence of wisdom in this case is not to commit yourself to a course of action."

But other economists say the Fed is caught between hoping for inflation pressures to retreat and hoping for the economy to show some improvement, despite recent reports on consumer confidence, jobs and the housing market showing further weakness.

"The Fed seems to be focused on a strengthening economy. But assuming does not make it so," said Bob Brusca of FAO Economics. "Inflation risks will diminish only when you hike rates." To top of page

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