Fed nods to easing inflation, but still worried

Washington, June 29: The Federal Reserve on Thursday held benchmark U.S. interest rates steady and, while nodding to a recent easing in core inflation, restated that inflation remained its top concern.

The decision by the central bank's Federal Open Market Committee keeps the overnight federal funds rate target at 5.25 percent, the level it hit in June last year after 17 straight quarter-percentage point increases.

In a statement outlining its decision, the U.S. central bank dropped a reference describing core inflation as ''elevated'' that had been in its two prior rate announcements, but expressed concern, nonetheless, that the easing in nonfood, nonenergy price increases could prove fleeting.

''Readings on core inflation have improved modestly in recent months,'' the FOMC said. ''However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated.'' ''The committee's predominant policy concern remains the risk that inflation will fail to moderate as expected,'' it said, adding that tight economic conditions were keeping that risk alive.

The dollar held steady but stocks pared gains and prices for U.S. government bonds slipped on the announcement, as traders saw it signaling less likelihood the central bank would lower interest rates later in the year.

''Clearly, the bias is not going to be a rate cut,'' said Giri Cherukuri, head trader at Oakbrook Investments in Lisle, Illinois.

Core inflation moderated in May and April to within range of policy-makers' presumed comfort zone of 1 percent to 2 percent.

The central bank has left borrowing costs unchanged over the past year, expecting prices pressures to ease as the economy moves forward at a somewhat sluggish pace on the back of a big slide in the housing sector.

''Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector,'' the Fed said. ''The economy seems likely to continue to expand at a moderate pace over coming quarters.'' However, officials have remained concerned that a tight labor market that could force employers to boost wages to find and retain workers. In May, the unemployment rate held at a low 4.5 percent.

In addition, overall inflation climbed sharply in May, spurred by higher food and energy prices, which could feed through to prices elsewhere and drive core inflation higher.

Adding to inflation angst, the government's final revision to first-quarter growth data released on Thursday put core inflation higher than first believed in the January-March period, fanning some worries that inflation may not be as low now as Fed officials had hoped.

At the same time, the Fed has also had to weigh lingering concerns about economic weakness as problems in U.S. mortgage markets have delayed recovery of the housing sector.

A rise in long-term interest rates that has pushed up the cost of buying a home adds to obstacles to overcome.

U.S. output expanded at a scant 0.7 percent annual rate in the first quarter, but robust hiring in May and signs of a resurgence in factory activity have pointed to stronger growth in the current quarter.

However, an unexpectedly big tumble in May orders for long-lasting goods announced by the government on Wednesday raised questions about the strength of the factory sector and business investment spending plans.

Fed officials used this week's meeting in part to prepare their semiannual economic report to Congress. Fed Chairman Ben Bernanke is expected to deliver the report with two days of testimony in mid-July.

Reuters>