The US Federal Reserve has kept interest rates unchanged at 5.25%. It said inflation is still the biggest danger to the US economy. The policy statement maintains tightening bias and says "downside risks to growth have increased somewhat; " but the directive does acknowledge tighter credit conditions. The Fed added that despite the volatility in financial markets, the US economy is likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

The Fed policymakers didn't signal that a rate cut -- as an insurance policy against undue economic weakness -- would be imminent. Analysts believe the Fed probably will leave rates alone at its next meeting on Sept. 18. But economists and investors think the odds are growing that the Fed might lower rates by the end of this year, if the economy shows signs of faltering and if inflation isn't worrisome.

Although the downside risks to growth have increased somewhat, the FOMC's predominant policy concern remains the risk that inflation will fail to moderate as expected," the FOMC said in a statement following the meeting behind closed doors.

Reacting to this, Geoff Lewis of JF Asset Management said, "If the Fed had surprised with a move towards easing and had talked nore about the subprime crisis then it would have been undermining its own prior position that mortgage problems are not big enough to warrant a major systemic problem for the US. By acknowleding volatility the Fed has said that it will stick to its present policy of concern for inflation which remains above its comfort zone."

The Fed said that it still expects moderate growth in coming months, despite volatile financial markets, tighter credit conditions and the ongoing correction in the housing market. In the past weeks, the turmoil in the mortgage market has spilled over into the broader market for credit. There has been sharp volatility in equity markets. Stocks rode another wave of volatility on Tuesday, swinging 100-points in both directions becore closing with modest gains. Analysts said the Fed's optimism that the economy would muddle through played a role in the gains.

On inflation, the Fed repeated its statement from June that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated." It said the risk that inflation will fail to moderate was its "predominant policy concern."

Core consumer inflation increased 0.1% for the fourth consecutive month in June, pushing the yearly gain down to 1.9% in the past year, the lowest inflation since early 2004, and just within the Federal Reserve's unofficial comfort zone of 1% to 2% for core inflation. Core inflation excludes volatile food and energy prices.

The FOMC statement read as follows:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; William Poole; Eric Rosengren; and Kevin M. Warsh.