The U.S. Federal Reserve Board raised its target for the federal funds rate by 25 basis points to 5.25% on Thursday.

“Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices,” the Fed said in a release.

As readings on core inflation have been elevated in recent months, ongoing productivity gains have held down the rise in unit labor costs while inflation expectations remain contained. However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.

Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Fed maintains that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.

In a related action, the board of governors unanimously approved a 25-basis-point increase in the discount rate to 6.25%.

According to Bay Street economists, the Fed’s statememt is a little more dovish than markets expected.

“The real meat of the decision was contained within the accompanying text, which signaled a slightly more dovish tilt than the market had anticipated,” comments TD Bank. “The May 10th statement left the impression that the Fed was going to hike today unless the data came in soundly against them, today’s statement suggests that the Fed may need to be persuaded by the data to hike again on August 8th.”

“The Fed is now recognizes that the slowdown in economic growth due to the impact of past rate hikes and cooling housing activity should limit inflation pressure over time,“ says National Bank Financial. “Having said that, inflation remains clearly a risk factor from their point of view.”

Bank of Montreal says that the one report that will carry the most weight at the August 8 policy meeting is the June CPI release. “Since core CPI inflation will likely remain at 2.4% or even move higher, we think policymakers will feel compelled to move one more time, taking the federal funds rate to 5.50%,” it predicts. “Thereafter, we expect the Fed to remain on the sidelines as growth moderates in the second half of the year, and eventually to begin trimming rates late in the year.”

NBF adds that the press release suggests that some FOMC members are becoming more nervous about over-tightening. “More than ever, the Fed remains data-dependent and has not made its mind yet about the outcome of the August meeting,” NBF concludes. “A rate hike is still possible and probable if inflation numbers come out on the strong side but the probabilities are nowhere near as high as what was assumed before today’s announcement.”

BMO Nesbitt Burns notes that the market is still pricing 90% odds of one more 25 bps move among one of the next two FOMC meetings (August 8 and September 20). “We judge that the Fed really has no interest in hiking rates further,” it concludes. “They see economic growth easing, sufficient to flush inflation pressures away, and do not want the economy to slow more than necessary. However, as the market continues to question Bernanke’s inflation-fighting credibility, and if the data continue to show accelerating core inflation while the slowing economy metrics are muddled, the Fed might have no choice but to hike one more time.”

“Our call had been for a pause after today, and, at this point, we’re going to hold to that view until we see how the data unfolds, just like the Fed. One thing is certain; expect that hawkish rhetoric to intensify from the Fed as it talks up the talk in the hope of not having to walk the walk again,” BMO Nesbitt says.

“While it is impossible to rule out further hikes by the Fed, we suspect the Fed’s base case is now to pause on August 8th, and that it would take some convincing economic and/or inflation data to persuade them otherwise,” TD declares. “As a result, the fact that the Eurodollar market was pricing in a full rate hike for August strikes us as excessive. Still, the Fed remains heavily data dependent, and so the economic and inflation numbers that arrive over the next six weeks will be of great importance. We suspect this time span will reveal a softening economic picture, thus enhancing the likelihood of a pause after seventeen consecutive 25bp rate hikes.”