The U.S. Federal Reserve on Thursday kept the federal funds rate steady as expected and signaled that it is not yet satisfied with the recent drop in core inflation.

The Federal Open Market Committee voted unanimously to hold the federal funds rate at 5.25%, where it has stood since June of last year, a period encompassing eight meetings.

“Readings on core inflation have improved modestly in recent months,” the Fed said in a statement. “However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated,” it said.

Despite the recent drop in core inflation, the “predominant” concern is that it will fail to moderate as expected, the Fed said.

As expected, the Fed upgraded its assessment of the economy, saying growth has been “moderate.” It repeated its forecast for “moderate” economic growth in the months ahead.

The Fed continued to describe the adjustment in housing as “ongoing”.

Bay Street economists disagree on whether the Fed will hold steady for the rest of the year.

TD Bank economists say there were few fireworks in the announcement’s policy statement. “In the economic assessment, it did recognize that the economy has been rebounding from the very weak performance recorded in the opening quarter of the year,” it noted. “But at the same time, the Committee also recognized that inflation has been coming down.”

“All told, while the Fed does acknowledge some improvement, it is not about to take its eyes off the inflation ball,”’ TD concludes. “The bottom line is that the Fed appears set to remain on hold for the foreseeable future.”

“Although underlying economic growth remains modest at best, and although there is still a risk of larger spillover effects from the housing market, the U.S. economy is still holding up well enough to rule out rate cuts for the time being,” it adds. “And, although inflation risks are still very much alive, core inflation has actually been cooling down, and with the economy merely chugging along, the odds that the Fed will hike rates over the near term are just as remote.”

National Bank Financial however, believes that by the fourth quarter the Fed will be in a position to lower rates. “First, we doubt that the second-quarter rebound of the U.S. economy is the beginning of a trend; we still forecast growth to fall back below par again in the third quarter. Second, we continue to expect core CPI to decelerate and to settle below 2% by this winter on the back of significant disinflation in housing,” it says. “In our view, this combination of slow growth and tame inflation will allow the Fed to notch down its target rate. We accordingly see a quarter-point cut in December or January and another later in Q1 2008.”