Fed holds interest rates steady

The stock market has also been rallying on increased confidence that the U.S. economy will enjoy a successful "soft landing," rather than a more painful recession. Broad indexes including the Dow Jones industrial average are near their highest levels since the bull market peak of early 2000.

After a strong showing of a 5.6 percent annual growth rate in the first quarter, the economy slowed to just a 2.9 percent pace in the second. Economists look for even slower growth over the second half of the year.  A Reuters poll of 69 economists released Monday found a median prediction of a one in four chance of the U.S. economy slipping into recession next year.

Saving billions at the pump
With energy prices falling, consumers are getting immediate inflation relief at the pump. After peaking just over $3 a gallon in mid-July, gasoline prices have fallen to an average of about $2.60 as of last week — with further prices drops expected. In some parts of the country, pump prices have fallen back through the $2-a-gallon mark.

Energy analyst Peter Beutel estimates that consumers save about $3.8 million a day for every penny knocked off the price of a gallon of gasoline. That means consumers have saved billions of dollars from falling pump prices in the past month.

A sustained drop in energy prices could also take price pressure off airlines, shippers and other transportation companies that have been passing along their higher fuel costs to consumers.

“With the housing sector now in a recession, with the inflation scare largely over, there's no reason at all for the Fed to raise rates,” Morgan Stanley chief economist Stephen Roach told CNBC Monday. “They’ll certainly stand pat and they'll continue to do that, and I think there's good chance they'll be talking about easing (rates) in early '07.”

But some economists say it's too early to begin looking for the Fed to cut rates. Former San Francisco Fed governor Robert Parry is among those who believe the rate-setting committee thinks inflation rates are still too high.

“I think there's a tightening bias for a very good reason,” he told CNBC shortly after the Fed’s annoucement. “If you look where inflation rates are and have been, they've been outside the range of what the Fed is thought to have as its tolerance area. ... I think it's very valuable for them to make it perfectly clear that they have their eye on inflation and know that it isn't where they'd like it to be.”

Higher energy prices have been just one of several factors pushing prices higher. After years of price-cutting made possible by lower manufacturing costs overseas, prices of imported goods have begun rising — thanks to a drop in the value of the dollar.

“Import prices were falling from 1995 to 2001 and early 2002,” said David Huether, chief economist at the National Association of Manufacturers. “When the dollar started coming down, within a quarter or so you saw prices of imports start to pick up. They’re not deflationary any more.”

Even if energy prices remain at lower levels – and that’s a big “if” – the folks at the Fed pay closest attention to the so-called “core” inflation rate - the statistic that excludes food and energy prices because they are subject to big, sudden ups and downs.

“(Core) inflation is already above the top of the Fed’s target,” said Hoffman. “Right now, they’re being patient. But it’s not like it’s been is at the lower end of the range and is starting to accelerate. It’s already gone through the presumed 2.0 to 2.5 percent threshold.”

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