The Fed’s Open Market Committee kept its target for the federal funds rate unchanged today, at 2 percent. The prime rate will remain 5 percent. Home equity lines of credit and most variable-rate credit cards are indexed to the prime rate, so their rates will remain unchanged. Long-term interest rates, such as those paid on fixed-rate mortgages, are governed by market forces and don’t necessarily follow the Fed’s lead.

Among economists, the consensus is that the Fed won’t change short-term rates until late this year or early next year — and when that time comes, the central bank will raise rates to combat inflation. In the meantime, the Fed’s preferred inflation-fighting weapon will be “jawboning,” or “trying to talk inflation down instead of doing something about it,” in the wry words of Kenneth Thomas, finance lecturer at the University of Pennsylvania’s Wharton School.

In a statement explaining its interest rate policy, the Fed said tight credit, the slumping housing market and higher fuel prices will weigh on economic growth in the next few quarters. It added: “Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated.”

Richard Fisher, president of the Dallas Fed, cast a dissenting vote. He wanted to raise the federal funds rate.

No one was surprised by the Fed’s decision to keep rates steady. The central bank likes to foreshadow rate changes, and did nothing of the sort over the past few weeks. Fed officials have been in wait-and-see mode for months as the economy has slowed down while, at the same time, prices have risen swiftly.

The rate-setting committee meets eight times a year. In the previous seven meetings dating back to last summer, the panel cut rates. The reduction in the federal funds rate was unusually rapid, going from 5.25 percent in September to 2 percent in April, as the Fed fought off a credit crunch.

With the economy in a slump, and with prices rising rapidly, the Fed has found itself in a dilemma. Short-term rates already are low, and if the central bank cuts them more to stimulate economic growth, then prices could rise even faster and get out of control. If the Fed raises short-term rates, the result could be a recession (or a deeper recession, if the economy already is in one) and a delayed recovery.

Fed Chairman Ben Bernanke and all but one of his central bank colleagues agreed that the best course was to leave a key rate alone at 2 percent, as the country slogs through the crosscurrents of plodding economic growth and zooming energy and food prices that threaten to spread inflation.

That meant the prime lending rate for millions of consumers and businesses stayed at 5 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans.

The decision brought to a close a powerful series of rate reductions that started in September and extended through late April. It was the central bank’s most aggressive intervention in two decades to shore up an economy bruised by the trio of housing, credit and financial crises.

On Wall Street, stocks ended with a modest gain. The Dow Jones industrial average closed up 4.40 points to 11,811.83. Broader stock indicators managed to log stronger gains than the blue chips.

The Fed said it believes its rate cuts will “promote moderate growth over time” as they work their way through the economy. It also said risks that economic growth will falter appear to have “diminished somewhat.”

The Federal Reserve cut its target for the federal funds rate by a quarter-point, from 2.25 percent to 2 percent. The prime rate will fall by a quarter-point, from 5.25 percent to 5 percent. The move spells good news to people who borrow money on loans, such as home equity lines of credit, that are linked to the prime rate. It’s not such good news for savers who want to put their money in short-term certificates of deposit.

The rate-setting Federal Open Market Committee has been slashing rates to encourage consumers to borrow, and therefore stimulate the faltering economy. At the beginning of September, the federal funds rate stood at 5.25 percent; since then, the Fed has cut it by 3.25 percentage points. It has been an unusually rapid series of rate reductions, as the Fed has tried to catch up with the economic slowdown brought on by the housing slump.

“Recent information indicates that economic activity remains weak. Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation have risen in recent months. The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to moderate growth over time and mitigate risks to economic activity,” according to the Fed announcement.

The Federal Reserve knocked 25 basis points off a key interest rate.

This rate cut had been expected, with futures markets pricing in a 1-in-5 chance that the Fed would keep rates unchanged, and a 4-in-5 chance of a quarter-point cut. To the extent that anyone expected the Fed to keep rates unchanged, that sentiment stemmed from the inflation picture. As anyone who drives to the grocery store knows, prices for gasoline and food have been skyrocketing and threatening to eventually push up prices for everything.

Typically, rate cuts make inflation worse. That makes the case for holding short-term rates steady. But this isn’t a typical situation. Prices aren’t rising because the economy is booming; instead, they are rising despite an economic downturn.

“It’s a compromise between two equally persuasive arguments,” says Richard DeKaser, chief economist for National City Corp. “On the one hand, there’s an increasingly legitimate argument that inflation needs to be pre-empted more aggressively.” On the other hand, he says, “there is still risk to the economy in terms of weaker growth.”

Why? I see three reasons. First, the Fed spent the past nine months ushering homeowners with adjustable rate mortgages to safety by drastically cutting short-term interest rates. They did so to such an extent that many homeowners saw negligible rate resets in 2008, unlike the experience of their neighbors in 2007. This has prevented untold additional foreclosures and, given the significance of this relief, the Fed will be unwilling to throw those same homeowners back under the bus by raising interest rates too much, too soon.

Secondly, the weakness in the broader economy and the tenuous improvement in credit markets provides little latitude for the Fed to raise interest rates. And finally, the looming presidential election - although it shouldn’t factor into the equation - makes this a particularly sensitive time for the Fed to consider any interest rate increases. Can you imagine the field day the candidates would have if the Fed raised interest rates prior to the election? One other tidbit: The decision to appoint Ben Bernanke to another term as Chairman of the Fed, or not, will rest with the winner of the upcoming election (Bernanke’s term expires in 2010).

Don’t get me wrong. I’m not saying the Fed shouldn’t do whatever is necessary to tame inflation. (I personally think they should). But I am saying that it will be difficult for them to raise interest rates anytime soon, even if the inflation picture gets worse. The Fed continues to believe that inflation will moderate on its own, though you can sense some waffling in that stance as oil goes higher. Let’s hope they’re right.

The inflation component is combined with the fixed rate to give the total earnings rate. Due to high inflation we’ve been experiencing, the inflation component is a very high 4.84% so the the combined rate is a respectable 4.84%. However, with a 0% fixed rate, the earnings now will just keep pace with the government reported inflation (CPI-U).

With this new low fixed rate and the recent purchase limit reductions, these I Bonds have lost much of their appeal.

However, it kept its options open and financial markets saw some chance more rate cuts could be in store.

In announcing its decision, the U.S. central bank pointed to the “substantial” reductions it has already put in place and noted that energy and other commodity prices were on the rise. It also dropped a reference contained in its last interest-rate announcement that “downside risks to growth remain.”

“The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity,” the central bank said.

While the Fed said uncertainty on the outlook for prices remained high, it also said it still believed inflation would moderate over time, which some analysts saw as suggesting the possibility rates could move lower. Two Fed officials dissented from the decision to cut rates, preferring no change.

Nobody really knows how soon the Fed’s rate cut will impact mortgage rates, or which direction rates will likely go.

For this reason, consumers are urged not to wait for the market to bottom before looking for a mortgage.
“I am absolutely a believer that taking action now makes sense.”

“I am absolutely a believer that taking action now makes sense,” says Bob Walters, chief economist at Quicken Loans.

Although rates have been trending higher in recent weeks, they remain low by historical standards. So if you’re looking for a mortgage, the time to act is now.

It’s a bit easier to determine when the Fed rate cut will affect borrowing costs on adjustable-rate mortgages: You are likely to see a benefit the next time your mortgage resets.

The strong Fed action seemed to convince investors, at least for now, that the central bank will do whatever it can to keep the country out of a steep recession. The Dow Jones industrial average finished the day up 420.41 points at 12,392.66.

The latest Fed move brought the federal funds rate — the interest that banks charge each other — down to 2.25 percent, the lowest since late 2004.

That’s important far beyond bank boardrooms. The reduction triggered announcements from commercial banks that they were cutting their prime lending rate to 5.25 percent from 6 percent. This rate is the benchmark for millions of business and consumer loans.

In addition to Friday’s employment report, tomorrow brings the ISM Services Index. That same index ignited the recession concerns a month ago when it plunged sharply, showing a contraction in the important services sector of the economy. A similarly poor reading this month would bring out the economic boo-birds calling for the monetary policy equivalent of a quarterback change … in other words, an immediate interest rate cut. Lock in your rates now if you can, because the future doesn’t look pretty for savers.