Fed Leaves Benchmark Interest Rates Unchanged, Warns of Inflation

The Federal Reserve left a key interest rate unchanged Wednesday but triggered a strong rally on Wall Street as investors took hope the central bank might cut rates in the future.

Fed Chairman Ben Bernanke and his colleagues voted to keep the federal funds rate, the interest that banks charge each other, at 5.25 percent. It was the sixth straight meeting at which the Fed has not changed the rate.

In the statement explaining its action, however, the Fed this time dropped language about possible future rate increases. Any "future policy adjustments" would depend on the performance of both inflation and the economy, according to the statement.

Financial markets saw that change as a sign the Fed was considering future rate cuts and was not just focused on raising rates.

Investor euphoria over the possibility of rate cuts pushed the Dow Jones industrial average up by more than 160 points in the hour of trading following the Fed's midafternoon announcement.

Economists cautioned that investors probably were getting too enthusiastic about the likelihood the Fed would cut rates any time soon.

They noted the Fed statement also expressed increased worries that inflationary pressures have risen. The statement said that risks of inflation were the Fed's "predominant policy concern."

Analysts said the central bank appeared to acknowledge it is in a bind, caught between an economy being dragged down by troubles in the housing industry and stubbornly high inflationary pressures.

David Jones, chief economist at DMJ Advisors, said he did not expect any Fed rate changes before September at the earliest. At that time, he said if inflationary pressures have eased, the Fed might cut rates once or twice this year.

"This is a less favorable inflation environment and a less favorable economic environment," Jones said. "They have got to let the dust settle on this very mixed picture before they do anything."

The Fed's discussions Tuesday and Wednesday occurred in a very different environment from their last meeting, Jan. 30-31.

Since then, financial markets in the United States and elsewhere have given investors some stomach-churning days, including a 416-point drop in the Dow Jones industrial average Feb. 27.

That decline resulted in part from troubles in the mortgage lending industry and worries that recession risks were increasing.

The Fed, taking note of the weaker readings on the economy, said, "Recent indicators have been mixed and the adjustment of the housing sector is ongoing."

But the Fed retained language from past statements that expressed belief the economy will keep growing at a moderate pace.

The Fed's decision to keep rates steady was expected. In recent comments, Bernanke and other Fed officials said they had not seen anything to change their expectations that inflationary pressures will moderate this year and economic growth will rebound.

The Fed last changed rates in June 2006 when it capped a two-year credit-tightening campaign with a 17th quarter-percentage point rate increase. That move pushed the funds rate to 5.25 percent. It had stood at a 46-year low of 1 percent when the Fed began raising rates in June 2004.

The decision Wednesday means that borrowing costs for millions of consumers and businesses will be unchanged, with banks' prime lending rate staying at 8.25 percent.

The recent market troubles were blamed in part on rising financial strains among lenders dealing in risky loans — subprime mortgages made to borrowers with weak credit histories.

Investors were also unnerved by comments that former Fed Chairman Alan Greenspan made about the possibility of a recession occurring by the end of this year. Greenspan has put the odds at one in three.

Normally, the central bank would respond to spreading economic weakness by cutting interest rates. But two reports on inflation last week showed that price pressures are a problem, with both wholesale and retail prices rising more rapidly in February.

Excluding food and energy, consumer prices have been rising this year at an annual rate of 3 percent, far above the Fed's 1 percent to 2 percent comfort zone.