Fed leaves interest rate at 5.25%

NEW YORK -- The Federal Reserve, keeping interest rates unchanged, said yesterday inflation is still the biggest danger to the economy and that the six-year economic expansion won't be undone by tighter credit conditions.

"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 Federal Open Market Committee said after meeting yesterday in Washington, where it left the benchmark rate at 5.25 percent.

Some investors read the remarks to mean that chairman Ben S. Bernanke won't rush to cut rates in response to a rout in the subprime mortgage market that has prompted lenders to restrict borrowers' access to credit with higher rates and fewer down-payment concessions. The world's largest economy will survive the tumult, the central bank added.

"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."

Traders pared bets on the chance the Fed will lower rates in the next few months, according to futures prices on the Chicago Board of Trade. The Dow Jones Industrial Average fell in the minutes after the decision, before rebounding.

"They are sticking to their guns," said David Kelly, an economic adviser at Putnam Investments LLC in Boston, which manages $193 billion in assets. "They think the economy is fundamentally healthy and it will get through the credit-market issue. They don't want to do anything to panic."

The mention of inflation as the "predominant" concern has appeared in each Fed statement since March and meeting minutes starting with last December's session.

Slower productivity growth may boost inflation because it means companies have less cushion to absorb wage increases without raising prices. A government report yesterday showed productivity rose at an annual rate of 1.8 percent in the second quarter, less than the 2 percent gain expected, based on the median forecast in a Bloomberg News survey.