Fed seen holding rates steady as growth stumbles

By Mark Felsenthal

WASHINGTON (Reuters) - The U.S. Federal Reserve on Tuesday began a one-day meeting at which it is expected to hold interest rates steady amid poor housing and credit conditions, while signaling inflation concerns even as oil prices ease.

A statement from the Fed's newly expanded Federal Open Market Committee outlining its decision and thinking on the economy is due around 2:15 p.m. (1815 GMT).

Just before the meeting started, the Fed swore in veteran community banker Elizabeth Duke as a new board member who will vote on Tuesday's policy decision.

The action may give Fed Chairman Ben Bernanke a valuable ally on interest-rate policy at a difficult juncture.

With commodities prices soaring, Bernanke has faced several dissents in recent months from regional Fed bank presidents favoring higher rates. While little is known about Duke's views on monetary policy, Fed board members rarely dissent.

Facing the highest U.S. unemployment rate in four years and the lowest existing-home sales pace since early 1998, policy-makers will be more downbeat about the growth outlook than they were at their June meeting, when they said they saw risks tapering off.

"The mention in the last statement that downside growth risks appeared 'to have diminished somewhat' now looks like a premature conclusion," JPMorgan economist Michael Feroli wrote in a note to clients.

The Fed held the interbank federal funds rate steady at 2 percent at its June 24-25 meeting, and has suggested it hopes rate reductions totaling 3.25 percentage points since mid-September will be enough to help the economy rebound.

While growth in gross domestic product in the April-June period was a relatively strong 1.9 percent, many economists expect activity in the latter half of the year to weaken as consumer spending spurred by government stimulus checks fades.

In addition, signs that growth in economies around the world may be slowing is an ominous sign for U.S. exports, which have been one of the few areas of strength.

SERVICES CONTRACT SLIGHTLY

As the Fed was meeting, a key measure of the U.S. services sector showed the sector shrank slightly in July, though by less than economists had forecast.

The Institute for Supply Management said its non-manufacturing index was at 49.5 for July compared with 48.2 for June. A reading below 50 signals contraction, and economists polled by Reuters forecast the index at 48.5.

The service sector represents about 80 percent of U.S. economic activity, including businesses such as banks, airlines, hotels and restaurants.

The Fed must also factor continuing credit strains into its outlook. A weakened banking sector continues to tighten lending, suggesting less credit will be available to support the economy in months ahead.