Federal Reserve holds US rates at 2 per cent

The Federal Reserve held US interest rates steady last night, continuing its wobbly tightrope walk between fears of surging inflation and concern that the credit crisis could send the economy into a dive.

Holding the main interest rate at 2 per cent, the Federal Open Market Committee (FOMC) said inflation has been "high" but insisted that price rises will eventually moderate.

And as it did so, the price of crude oil continued to decline, dipping below $120 in New York and easing some of the pressure on the US consumer, one of the most important engines of global economic growth.

Since the last FOMC meeting in June, the financial system has been hit by the collapse of IndyMac, one of the biggest banking failures in history, and a crisis of confidence in the mortgage giants Fannie Mae and Freddie Mac, which were granted a government bail-out. However, the US economy has continued to grow, giving the Fed room to breathe after the dramatic series of actions that took the main interest rate down from 5.25 per cent last September.

Stock markets had rallied yesterday in expectation of a steady-as-she-goes decision, and stayed high in the aftermath, as investors judged that the statement has done nothing to change the outlook for rates. Financial markets are betting on an eventual moderate rate rise before the end of the year, and the FOMC promised it will "continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability".

The FTSE 100 had closed last night up 134.3 at 5,454.5 before the decision. The Dow Jones Industrial Average closed up 331.62 at 11,615.77 as investors reacted positively to the decision.

Joe Davis, chief economist at the fund manager Vanguard in Pennsylvania, said he was happy there were no surprises from the Fed. "They are trying to navigate a very tough climate," he said. "In this environment, the best is to do nothing."

The Fed said: "Labour markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth."

In New York, the price of a barrel of crude oil fell by a further $2.24 to $119.17, compared with its peak above $145 last month and its lowest close since 2 May. Traders have seen gathering evidence that high prices are forcing consumers – drivers in particular – to change their habits, eroding demand.

There was other positive news earlier in the day. A measure of the US service sector, the Institute for Supply Management's index of non-manufacturing businesses, showed the sector contracted for the second month in a row in July, but by less than expected. The service sector accounts for 90 per cent of the US economy.