The US Federal Reserve has left its key interest rate unchanged, but signalled it is becoming more inclined to tighten monetary policy in the months ahead.

The Federal Open Market Committee (FOMC), the Fed’s monetary policy committee, concluded its two-day meeting with a statement confirming expectations that the fed funds rate would stay at 2.00 per cent.

As the sub-prime loans crisis unfolded last year the Fed cut fed funds rate from 5.25 per cent, in seven steps beginning in September and including an unscheduled meeting in January.

This marks the first FOMC meeting since August which has not ended in a rate cut.

The statement included a strong hint that the next move may be upward.

“Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased,” the FOMC said in its statement.

The Fed is still obviously worried about ongoing fallout from the sub-prime loans crisis, which has destabilised financial markets around the world.

“Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters,” the committee said.

The committee also noted ongoing stress in financial markets and softening labour markets.

It also downplayed fears that inflation is ratcheting higher.

The US consumer price index (CPI) rose by 0.6 per cent in May, according to data released by the Bureau of Labor Statistics earlier this month, with annual inflation at an uncomfortable 4.2 per cent.

However the the “core” rate, which excludes the volatile food and energy components, rose at only 2.3 per cent over the year to May.

“The Committee expects inflation to moderate later this year and next year,” it said.

This suggests any move in rates could be quite a few months away.

Even so, the shift in its concerns over inflation, and the fading fears of recession, is clear.

The committee acknowledged that the economy, contrary to widespread expectations of a slump earlier in the year, continues to grow.

“Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending,” the FOMC said.

And its optimism over inflation was tempered with caution.

“However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high,” the policymakers said.

For central banks, the standard response to an uncertain inflation outlook is to cover that risk with with insurance in the form of higher interest rates.

Earlier this year the futures market had factored in another two cuts of a quarter of a percentage point in the fed funds rate, with a minor risk of a third taking it to 1.25 per cent.

But as recession fears abated and inflationary pressures picked up, the consensus swung around 180 degrees.

Prior to this meeting the market had put fed funds at 2.50 per cent by the year’s end.

The Fed’s decision and statement have not altered that view built into futures prices.

AAP