Fed keeps US rates on hold; acknowledges market turmoil

WASHINGTON (AFP) - The Federal Reserve Tuesday kept US interest rates unchanged at 5.25 percent but it acknowledged concerns about tightening credit and a persistent housing market slump dogging the US economy.

The central bank has now kept US interest rates steady for just over 13 months. The 10 policymakers of the Federal Open Market Committee, led by chairman Ben Bernanke, voted unanimously to keep rates unchanged.

In justifying its decision, the Fed said the world's largest economy seems likely to continue expanding at a "moderate" clip, and that its top priority remains the fight against inflationary threats.

But policymakers conceded there were dark clouds looming on the economic horizon.

"Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing," the Fed said.

"Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy," the central bank said.

Carl Tannenbaum, a chief economist at ABN AMRO North America, said the Fed made the right rate call for August, that it did not want to trigger a market panic by slashing rates.

"They certainly had to make mention in the statement of what I would call the elephant in the room, which is that the credit markets right now are not functioning very well and they do represent a risk to the expansion," Tannenbaum said.

Most economists expected the Fed to keep rates on hold, but some economists say housing and credit problems could pressure the Fed to trim rates before the end of the year.

The Fed said future rate decisions would largely depend on the outlook for inflation and economic growth.

"Although the downside risks to growth have increased somewhat, the committee's predominant policy concern remains the risk that inflation will fail to moderate as expected," the central bank stated.

Joel Naroff of Naroff Economic Advisors said that despite the mortgage and credit woes, the Fed continues to signal that it will not cut rates until it believes "inflation is licked."

"Despite words about the credit issues, it is still all about inflation," Naroff said.

Fears about mortgage failures and tightening credit have sparked volatile trading on US stock markets in the past week.

Recent reports have suggested the worst of the housing downturn, which has also afflicted mortgage lenders, may be far from over.

US home sales fell much more heavily than predicted in June to their lowest level in over four-and-a-half years, and American Home Mortgage, one of the country's largest home finance firms, became the latest lender to seek bankruptcy protection this week.

Fed officials have said in recent months that they do not anticipate the housing slump destabilizing the broader economy, and consumer spending -- a vital motor of economic vitality -- appears to be holding up.

The world's largest economy has picked up speed, expanding at a 3.4 percent rate in the second quarter compared with its 0.6 percent crawl in the first three months of the year.

Some market watchers say a rate cut might not benefit the distressed housing market or the wider economy.

"As much as Ben Bernanke may want to play the hero, dollar weakness and persistent inflation pressures prevent the Fed from riding to the rescue of the credit markets," said Peter Schiff, a president of Euro Pacific Capital, Inc.

Schiff said a rate cut could cause mortgage interest rates, which track US Treasuries, to rise as overseas demand for American debt would fall.

Other economists, including Tannenbaum, believe the Fed will continue sitting on the rate fence for the rest of the year or until policymakers feel inflation threats have fully abated.

Central bankers typically cut interest rates when housing markets slow to aid homeowners, but persistent inflation concerns, particularly oil prices, have stopped the Fed cutting rates in the past year.

The Fed next meets to mull US rates on September 18.