Markets Rise After Fed Leaves Rates Unchanged

WASHINGTON, March 21 — The Federal Reserve acknowledged on Wednesday that economic prospects are mixed and edged away from previous signals that the most likely direction of future interest rates would be up. The central bank left the overnight federal funds rate at 5.25 percent, the level it has been at since last June.

But for the first time since it stopped raising rates, it omitted its statement indicating a bias towards raising rates rather than lowering them.

Only three weeks after global stock markets were embroiled in turmoil, investors reacted with relief to the modest change in tone from the Fed. The Dow Jones industrial average jumped 1.3 percent within minutes of the Fed announcement and stayed at that level, erasing nearly all of its its losses for the year so far. It closed at 12,447.52, up 159.42 points for the day.

In the past, the Fed has said that additional firming — rate increases — would be decided on the basis of the evolving economic outlook. On Wednesday, by contrast, it simply said that future policy adjustments will depend on the evolution of the outlook.

If anything, the statement showed a reluctant retreat from the Feds bias toward higher rates. It noted that readings on inflation had been elevated, a shift from its view after the policy meeting on Jan. 31 that inflation measures had improved modestly.

More pointedly, the Fed expressed a new sense of worry about its predictions for a gradual slowdown in price increases.

The committees predominant policy concern remains the risk that inflation will fail to moderate as expected, the Fed said in a statement accompanying the rate announcement.

That was a marked departure from Fed statements over much of the past year, in which officials simply cautioned that some inflation risks remain.

The Feds announcement highlighted the contradictory indications of recent economic reports, which have provided evidence of both slowing economic growth and stubbornly persistent inflation.

The United States economic expansion has slowed markedly in the last year, fluctuating between annual rates well below what economists consider the nations potential growth rate of 3 percent a year.

Economic growth varied from 2 percent to 2.6 percent during 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 percent to 2 percent a year.

In February, the Consumer Price Index jumped by 0.4 percent, up well over 2 percent from 12 months earlier. The core rate of inflation, excluding volatile prices for energy and food, was up 2.7 percent from one year earlier.

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

For the moment, Fed officials appear to remain convinced that the problems among subprime borrowers will affect only a small part of the overall housing market and pose little danger to the overall economy.

But the central banks tone was more uncertain on Wednesday. After its January meeting, the Fed declared that it detected tentative signs of stabilization in the housing market. On Wednesday, by contrast, it said that the adjustment in the housing sector is ongoing.

Ben S. Bernanke, chairman of the Federal Reserve, has been more optimistic about the economic prospects than his predecessor, Alan Greenspan. Mr. Greenspan, speaking to private conferences of investors, has cautioned that the United States is now in the sixth year of an economic expansion and that such times often produce the seeds of another downturn.

In an interview with Bloomberg News last month, Mr. Greenspan rated the probability of a recession in 2007 at about one-third — considerably 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 annual pace of about 3 percent in the second half of this year.

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