The US Fed has left interest rates unchanged at 1% following the latest meeting of the central bank.

Policymakers at the Federal Reserve have decided to keep US interest rates unchanged as evidence of an economic recovery gathers pace.

The central bank also indicated that rates will remain low for some time, saying that a small risk of an unwelcome fall in inflation exceeded chances of a sharp climb in prices.

In its statement, the central bank said that "the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level."

As a result, it argued that without risking inflation "policy accommodation can be maintained for a considerable period."

Former Fed governor Lyle Gramley said that the Fed could hold off changing interest rates for up to a year, with growth returning to 3.5% and unemployment begining to fall.

In its statement, the Fed said that consumer spending was firming but labour markets remained weak.

Helping the recovery

"They want to be more assured that faster growth takes hold and that the economy comfortably moves on to a faster track," said Lynn Reaser, chief economist at Bank of America Capital Management.

At its last meeting at the end of June, the Fed cut interest rates by a quarter of a percentage point amid concern that the US economy was yet to show a sustained revival.

Now there are increasing signals that a recovery has begun, but it is unclear whether it will be strong enough to bring down the US unemployment rate, which now stands at 6.2%.

Preliminary figures show that US GDP grew at an annual rate of 2.4% in the April to June period, compared with 1.4% in the first quarter, and the Fed has predicted that growth will accelerate in the second half of the year.

Retail spending

However, most economists believe that it will take growth rates of 3.5% to 4% to begin to bring unemployment down, especially as continued high productivity growth means that firms can produce more output with fewer workers.

Among the promising signs of future economic growth, the Fed could point to the monthly survey by the Institute of Supply Management which suggested that manufacturing production is picking up.

And retail sales appear strong, with large store sales running ahead of last year's by 3.1% in July.

The government is also sending out tax rebates to all families with children over the summer, which should help boost spending.

Deflation fears

Financial markets are still expecting interest rates to rise by the middle of next year, despite the Fed's statement that low inflation means it can keep rates down for a considerable time.

Treasury bonds briefly rose after the Fed's announcement before falling back to remain mixed, while stock markets pushed higher on the hopes that low rates would boost profits and sales, with the Dow Jones industrial average jumping nearly 30 points in the first hour after the announcement.

In the past month, the perception in the bond market that rates have bottomed out has led to a sharp rise in long-term interest rates, including mortgage rates.

And those rising rates have slowed mortgage refinancing, a big source of extra funds for consumers in the past year.

Another concern had been the rising level of consumer debt.

Figures for July showed that consumer credit stabilised at around $1.76 trillion - still a high figure if interest rates begin to rise further.

If the Fed were to raise rates, it could trigger a credit crunch, squeezing out the possibility of a recovery.

The state of the economy could also play a key role in the re-election campaign of President George W Bush, which is scheduled to take place in November 2004.

A strong economic recovery could improve his chances, while continued high unemployment could help his Democratic rivals.