Fed to hold rates steady, cite inflation worries

By Ros Krasny

CHICAGO (Reuters) - The U.S. Federal Reserve looks certain to hold interest rates steady when it meets this week and will likely restate worries on inflation, even while nodding to weak growth and an easing of price pressures.

The central bank has held benchmark overnight borrowing costs steady at 5.25 percent for six consecutive meetings stretching back to August. It will announce its decision on rates around 2:15 p.m. EDT (1815 GMT) on Wednesday.

The statement from the rate-setting Federal Open Market Committee after its last meeting on March 20-21 was notable for dropping the bank's explicit bias toward higher rates, a move seen by some as a baby step toward a cut later in 2007.

It also said, however, that its "predominant policy concern" was the risk inflation would not ease, and meeting minutes released a few weeks later showed the Fed had not really altered its views on the risks to inflation and growth.

Analysts believe the central bank will want more time to assess whether a softer pace of economic growth will lead inflation lower as they hope, and that it will once again leave its options open on the future direction of monetary policy.

"Bet on a Fed still on hold in May with their inflation bias intact, but with a somewhat softer view of current economic and inflation trends," said Scott Anderson, senior economist at Wells Fargo in Minneapolis.

"Flexibility on rates either on the upside or downside will remain of paramount importance."

Interest-rate futures, which are used as a measuring stick for potential Fed moves, show almost no chance the FOMC will cut rates by mid-year, and prospects for an ease in August are less than one-in-five.

The final major piece of data policy-makers will pore over at their one-day meeting came on Friday with a report on April nonfarm payroll growth.

That report showed a slowdown in jobs growth, with only a modest 88,000 new positions created, and a tick upward in the unemployment rate to a still-low 4.5 percent.

While a touch weaker than many had expected, most economists said the report was not dismal enough to knock the Fed from its anti-inflation perch.

"This data will tend to reinforce the prospect of an FOMC statement that is little changed from March," said Alan Ruskin, chief international strategist at Greenwich Capital Markets in Greenwich, Connecticut.

Others, however, noted it was the slimmest payroll gain since November 2004 and that a government survey of households released along with the data from employers showed a drop in employment of 468,000, suggesting overall weakness in the economy may have finally crept into the labor market.

"This report is a perfect set-up for the Fed to adopt a truly neutral policy stance at next week's meeting to replace the half-baked inflation bias that caused so much confusion in March," said Chris Low, chief economist at FTN Financial in New York. "The reality of the past six months is not only falling inflation but also dramatically weaker economic growth."

SLOW GROWTH, BUT ...