As expected, the U.S. Federal Reserve left rates unchanged at today’s Federal Open Market Committee meeting, but economists note it left the door open for further hikes if necessary.

Bank of Montreal observes that today’s stand pat decision was the first pause in 17 successive meetings. The federal funds rate target remains at 5.25%, up from a trough of 1.00% in June 2004, it says. One member, Richmond Fed President Lacker, dissented in favour of a 25-basis points rate increase, BMO added.

National Bank Financial points out that earlier today, unit labour cost inflation was shown hitting a cyclical high in Q2. “This development probably helps explain why today’s decision was not unanimous,” it says

“The Fed paused because economic growth has moderated in response to past increases in interest rates and energy prices, and a cooling housing market. As well, although core inflation remains “elevated,” it should moderate if the economy slows, as expected, in the year ahead,” BMO says, noting that the Fed continues to warn that “some inflation risks remain.”

“We believe growth will remain sufficiently low (2.8% in the second half of the year) to allow the Fed to stay on the sidelines for a while,” BMO predicts. “In fact, by December, an expected moderation in core inflation should allow policymakers to begin reducing rates to more neutral levels.” It expects the federal funds rate to decline to 4.50% by the spring of 2007.

NBF agrees that GDP growth must remain below 3% in the second half of this year to justify the Fed’s staying on the sidelines through the yearend. “In our opinion, this remains the most likely scenario,” it says.

“While the statement did not rule out further rate hikes, it certainly did not give the impression that its saw further tightening as a likely outcome – and in that sense, it can be seen as neutral to slightly dovish,” comments TD Bank.

“We remain of the view that the U.S. economy is in the very early stages of a mid-cycle slowdown, which will go a long way towards taking the edge off inflation down the road. Correspondingly, we do not believe the Fed has any more tightening up its sleeve,” TD concludes. “By the time the next FOMC meeting rolls around in late September, there will be more pervasive signs of slower growth, although measures of inflation are likely to remain above the Fed’s comfort level.”

BMO Nesbitt Burns stresses that, “It’s important to keep in mind that this is a policy pause, not a signal of a shift to a neutral policy bias. If the inflation trends deteriorate further (keep a sharp eye on 3- and 6-month growth in the core CPI and core PCE deflator), or should the growth damper on inflation no longer be projected as adequate, the Fed will likely resume rate hikes.”