Fed Weighs Words About Its Next Move

WASHINGTON, March 21 — The Federal Reserve, implicitly acknowledging hints of trouble in the economy, edged away Wednesday from previous signals that its next move on interest rates would be up.

To no ones surprise, the central bank left the overnight Federal funds rate at 5.25 percent, a level unchanged since last June.

But for the first time since it stopped raising rates, the Fed omitted a signal of its bias toward raising rates rather than lowering them. Investors reacted with relief, only three weeks after global stock markets were embroiled in turmoil.

The Dow Jones industrial average jumped 159 points, or 1.3 percent, within minutes of the Fed announcement and stayed at the level, erasing nearly all of its losses for the year so far. Bond prices jumped and bond yields declined on hopes of lower interest rates.

But the reaction may have been overly exuberant. Even as the Fed hinted at a more open mind about future rate increases, it seemed bent on discouraging hopes of cheaper money anytime soon. Indeed, it injected a new note of urgency about rising prices, calling them the predominant concern and expressing worry that inflation might prove more intractable than policy makers thought.

In the past, the Fed has said that additional firming — meaning rate increases — would be decided on the basis of the evolving economic outlook.

On Wednesday, it simply referred to future policy adjustments, which could mean rate increases or decreases. That was enough for investors to celebrate, with speculators in the Fed futures market putting the likelihood of a rate cut in June at 50 percent.

But the central banks Federal Open Markets Committee actually expressed more concern about inflation on Wednesday than it did after its last policy meeting on Jan. 31.

It noted that readings on inflation have been elevated, a shift from its view in January that measures had improved modestly.

More pointedly, policy makers expressed a worry that inflation might prove more stubborn than the Feds game plan had assumed. The committees predominant policy concern remains the risk that inflation will fail to moderate as expected, the Fed said in a statement accompanying its announcement to leave rates unchanged.

If anything, that was grimmer than previous statements that some inflation risks remain. Instead of implying that its job was nearing completion, the Fed statement suggested that the job might not be going according to plan.

We cant fathom how anyone could interpret the comments as a fundamental change in Fed thinking toward a neutral stance, wrote Bernard Baumohl, managing director of the Economic Outlook Group, a forecasting firm in Princeton Junction, N.J.

A more likely interpretation is that Ben S. Bernanke, the Fed chairman, recognized signs of trouble in the housing market and wanted to give the Fed more room to maneuver.

The Feds announcement highlighted the contradictory moves of the economy itself, which has provided evidence of both slowing economic growth and stubbornly persistent inflation. It also offered a clue about how central bank obfuscation will work under Mr. Bernanke, who succeeded the notoriously ambiguous Alan Greenspan as Fed chairman last year.

Mr. Bernanke favors openness and straightforward language more than Mr. Greenspan. But at a time when the economy could easily defy conventional wisdom, Mr. Bernanke devised a statement that left ample room for future rate increases as well as rate cuts.

The domestic economic expansion has slowed markedly in the last year to well below what economists consider the nations potential growth rate of 3 percent a year.

Economic growth fluctuated from 2 to 2.6 percent in the last three quarters of 2006, much slower than the pace in 2004 and 2005. Many economists estimate that growth for the first quarter of 2007 will be about 2 percent as well.

But inflation continues to run higher than the Federal Reserves unofficial comfort zone of 1 to 2 percent a year. Wages are climbing faster than productivity, and the wage component of production is rising.

In February, the Consumer Price Index jumped by 0.4 percent and was 2.4 percent higher than 12 months earlier. The core rate of inflation, which excludes the volatile prices of energy and food and which Fed officials consider a more accurate gauge of underlying trends, was up 2.7 percent.

Perhaps the biggest wild card for Fed officials is the housing market, where new construction has plunged and where acute problems among subprime mortgages for people with comparatively poor credit have prompted worries about the broader mortgage market and about the economy.

For the moment, Fed officials appear to think that the problems of subprime borrowers will inflict little damage on the broader housing market or the overall economy.

Still, the central banks tone was grimmer on Wednesday, implicitly acknowledging the implosion among top subprime lenders like New Century Financial.

Where the Fed saw tentative signs of stabilization in the housing market in January, on Wednesday it merely said that the adjustment in the housing sector is ongoing.

Mr. Bernanke has been more optimistic about the economic prospects than Mr. Greenspan. Speaking last month to private conferences of investors, Mr. Greenspan cautioned that the United States was now in the sixth year of an economic expansion and that such times often produced the seeds of a downturn.

In an interview with Bloomberg News last month, Mr. Greenspan rated the probability of a recession in 2007 at about one-third — more bearish than the Fed or most investors.

Mr. Bernanke, by contrast, told a Congressional hearing in February that the economy had slowed slightly, but was likely to pick up speed by this summer. The Federal Reserves consensus forecast — an amalgam of predictions by individual Fed governors and the regional Fed banks — anticipates that the economy will expand at an annual pace of about 3 percent in the second half of the year.

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