The U.S. Federal Open Market Committee decided today to keep its target for the federal funds rate at 5.25%.

In its statement the Fed the U.S. economy said the U.S. “economy seems likely to continue to expand at a moderate pace over coming quarters,” despite the adjustment in the housing sector.

The Fed also expressed concern about elevated readings on core inflation. “Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.”

The committee said its main concern is that “the risk that inflation will fail to moderate as expected.”

It added that future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth.

Bay Street economists are seeing rate cuts as a possibility, following the Fed’s shift to a more neutral policy stance,

TD Bank said that the rate decision was widely expected, so the real focus for the markets was on the post-meeting statement. “And, on that front, the Fed did pull a quick one out of its hat, by shifting its tone to a much more neutral one,” TD reports. “Most importantly, the reference to the possible need to tighten policy further that we had seen in the Fed’s past few statements is gone.”

TD notes that the statement was not completely devoid of any policy bias, “given that the Fed did re-emphasize that it still sees inflation as being the primary concern.”

“The Fed still has a bit of a bias, but it’s been seriously watered down,” TD concludes, adding that the change in tone is entirely justified.

“The odds that the Fed will indeed end up cutting interest rates are mounting. The housing market correction has not yet run its course and the risk of a spillover to other sectors of the economy are increasing,” it adds. “While the woes of the sub-prime mortgage market are making all the headlines — and certainly, that situation remains a wild-card – there is still a risk that consumer spending will soften up in response to the evaporation of housing wealth. Meanwhile, the business sector of the economy is losing momentum as well – not only is the ISM index bobbing around the 50 level, but the non-manufacturing ISM is weakening, and core capital goods orders are looking extremely soft. In our view, the risks are also mounting on the economic front – and correspondingly, we cannot quibble with the Fed’s change in tone.”

National Bank Financial agrees that the predominant policy concern for the FOMC remains inflation risks, however, it notes, “it nevertheless decided to give itself more room to manoeuvre by ending its press release with a less assertive view about the possible direction of future interest rates adjustments (previously a hike).”

“In our opinion, this change likely stems from the recent tightening in lending standards by banking institutions in reaction to the sharp deterioration in the subprime mortgages as well as to the significant drop in home completions that will take its toll on construction jobs,” it says. “With today’s press release, the FOMC is providing the least guidance in a very long time, a situation that reflects the uncertainty about the economic outlook. This also implies that we could see more volatile financial markets in the coming weeks as all options are now open; be it a rate increase or a rate cut.”

“In our view, the labour market still holds the key to the future direction of interest rates in the United States. For our part, we are maintaining that deterioration in labour conditions will pave the way for a Fed rate cut at the end of June,” NBF says.