US Fed holds rates at 5.25% but says inflationary risks remain

The Federal Reserve decided to hold its key short-term rate steady yesterday, saying economic growth had weakened, propelled by a "substantial" slowdown in the housing market. But it added that "some" inflationary risks remained.

At its final session for 2006, the policy-setting Federal Open Market Committee under the Fed chairman Ben Bernanke, the central bank announced the fed funds rate would remain at 5.25 per cent - where it has been held since August - after 17 successive quarter-point increases.

Nor did the Fed give much clue as to its intentions in the closely perused statement accompanying the decision, almost identical to that of the previous meeting.

Even the voting breakdown was identical. Once again, the sole dissenter was Jeffrey Lacker, the president of the Richmond Federal Reserve Bank, who believes a rate increase is required to keep inflation in check.

"The committee judges that some inflation risks remain," the FOMC said, adding that whether a further increase was required, and how large it should be, would depend on future developments in the economy.

Nonetheless, the Dow rose immediately after the announcement, reflecting the market's snap judgement that the Fed was now less likely to push up rates - and more likely to nudge them lower - as a result of the cooling economy, and an easing in headline inflation, after the steady fall in oil prices. Even so, "the Fed probably won't lower rates until late in the first quarter, maybe early in the second quarter of 2007," Bill Gross, the head of the PIMCO investment group, said.

The Fed's decision to hold rates steady may have been influenced by news of a fall in the country's trade deficit in October to $59bn (£30bn), 8 per cent less than in September, and the largest month-on-month decline in more than five years.

The Commerce Department's figures show the deficit could still hit $800bn this year. But the October returns suggest that declining oil prices and the falling dollar - making US exports cheaper - are starting to kick in.

However, the politically sensitive deficit with China climbed to $24.4bn from $23bn in September, ensuring the total bilateral deficit for 2006 is $200bn - most of which, if past practice is any guide, Beijing will reinvest in US securities, thus holding down the exchange rate of the yuan.

Despite the dollar's weakness, the authorities have permitted the Chinese currency to rise by only 3 per cent against the dollar over the past 17 months, far less than the euro and sterling.