As widely expected, the U.S. Federal Reserve Board voted today to keep its benchmark interest rate unchanged at 5.25%.

The Fed’s open market committee, headed by chairman Ben Bernanke, acknowledged that key sectors of the economy are cooling – most notably, housing and manufacturing. But it cautioned that “some” inflation risks remain.

“Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market,” the committee said in a five-paragraph statement released after the meeting.

“Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures,” the committee said.

“However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions.”

Today’s meeting was the last one in 2006. Many economists expect the Fed to begin lowering its key interest rate at some point in 2007.

Bay Street economists expect rate cuts to start in 2007.

Bank of Montreal notes that the Fed maintained a bias towards tightening, and Richmond Fed President Lacker, for the fourth straight time, dissented in favour of raising rates.

“The press statement was largely similar to the last one in October, although policymakers have more readily acknowledged the economic slowdown,” BMO says. “That said, the Fed reaffirmed that “some inflation risks remain” because core inflation remains “elevated” and “the high level of resource utilization has the potential to sustain inflation pressures.” This implies a tightening bias in policy, with the “extent and timing of any additional firming that may be needed” dependant on the incoming data on growth and inflation.”

The upside bias essentially rules out a rate cut at the next meeting on January 30/31, BMO said. “Nonetheless, we continue to believe that the next move in rates will be downwards. Continued moderate economic growth and an easing in core inflation should spur a rate reduction by the spring. In all, we see the fed funds rate declining to 4.50% by August 2007,” BMO predicts.

TD Economics says that the statement was slightly more dovish, but that the overall stance of the Fed remains “perched slightly on the hawkish side of neutral”.

“We continue to believe that the Fed will wind up cutting interest rates in 2007, with a first cut pencilled in for March,” TD predicts. “It simply appears that the Fed needs to see more weak data before capitulating. A partial push in this direction may come as upside dissenter Lacker leaves the slate of voters at the end of 2006. However, the voting panel will add Moskow, who is quite a hawk in his own right, and could take up Lacker’s mantle.”

“By keeping its tightening bias, the Fed is buying time,” National Bank Financial adds. “Thus even, if under Bernanke, the Fed will strive to conduct policy in a predictable (albeit flexible) manner, today’s decision in our view does not put at risk our forecast of a first rate cut in March. Indeed, the Fed still have plenty of time, including the January FOMC meeting, to adjust its message and prepare the market for a rate cut consistent with our U.S. economic scenario of sub-par growth well below potential for an extended period of time.”