The Washington Post

WASHINGTON (Reuters) – The U.S. Federal Reserve began a two-day policy meeting on Tuesday that was expected to end with benchmark interest rates on hold and little evidence the central bank is going to raise borrowing costs soon.

The Fed began its policy-setting meeting at around 2 p.m. EDT as scheduled, an official said. A decision on rates is expected to be announced about 2:15 p.m. EDT on Wednesday.

Fed Chairman Ben Bernanke and his colleagues confront a deepening housing market slump that looks set to be a drag on growth for months to come, and surging oil and commodity prices that threaten to ignite broader inflation.

While inflation risks have edged up and the economy has seemingly steered clear of the risk of a deep recession, policy-makers at the central bank have not fully set aside concerns about economic weakness.

The U.S. central bank lowered the interbank federal funds target rate to 2 percent at its last meeting on April 29-30, and has indicated it hopes rate reductions of 3.25 percentage points since mid-September will suffice to help the economy recover from the housing collapse and credit crunch.

“For now, policy seems well positioned to promote moderate growth and price stability,” Bernanke said on June 3.

Fed officials are in a bind. Raising interest rates to quell inflation would put a further brake on an already weak economy, while more rate reductions to buffer against a further stumble in output could add to price pressures.

Recent data highlights that dilemma. U.S. consumer sentiment slid to a 16-year low in June, while house prices continued their downward slide, reports showed on Tuesday.

At the same time, a measure of inflation expectations matched an all-time high this month. In addition, the largest U.S. chemical maker, Dow Chemical Co., said it would raise prices up to 25 percent on the heels of previously announced increases of 20 percent.

“We think the U.S. economy is still too fragile for a rate hike and thus expect the Fed to stay on hold — this time and also during the next meeting,” Harm Bandholz, an economist for UniCredit, wrote in a note to clients.

Fed officials have said that even though the unemployment rate jumped to 5.5 percent in May, the highest in more than 3-1/2 years, the risk that the economy will fall into deep recession has waned. But struggling housing markets and high energy costs still threaten economic expansion, they said.

Bernanke said that so far, higher raw materials prices have not passed through to lift prices for most other products and have not spurred demands for higher wages.

But he and other officials at the Fed have warned that there is no guarantee this pattern will hold, saying they are watching the inflation situation closely.

Policy-makers have also said the economy may be able to withstand a period of higher-than-desirable inflation without causing lasting damage as long as expectations for higher inflation do not build.

Any unmooring of inflation expectations could trigger a harmful spiral of rising prices and wages, they have warned.