WASHINGTON (Bloomberg) — The Federal Reserve kept the benchmark US interest rate at 5.25 percent and said inflation remains a risk while noting a “substantial cooling” in the housing market.“Some inflation risks remain,” the Federal Open Market Committee said yesterday after meeting in Washington. “The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth.”

Chairman Ben S. Bernanke, 52, anticipates the economy will withstand a downturn in housing and manufacturing, leaving the Fed free to focus on inflation. At the same time, policy makers acknowledged the worsening slump in residential real estate and foreshadowed growth of a “moderate pace on balance”.

“Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market,” the Fed said, adjusting the language used at the last meeting. “Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters.”

The dollar fell against the euro and bond yields fell after the decision. Stocks pared their decline.

“The only change I see is a somewhat more dovish assessment of housing,” said Jeffrey Kleintop, chief investment strategist at PNC Wealth Management in Philadelphia, which oversees $52 billion in assets. “For the next couple of meetings, they probably won’t make any more changes, but will have plenty of opportunities early next year to guide market expectations as to when cuts may begin.”

Yesterday’s decision extends a respite from two years of rate increases that ended in June. Bernanke and most of his colleagues are counting on the economy slowing enough to cool inflation without the need to resume tightening credit.

Richmond Fed President Jeffrey Lacker cast his fourth dissent in favour of raising the overnight lending rate between banks to bring inflation down at a more rapid pace. Lacker won’t vote again until 2009. Chicago Fed President Michael Moskow, who stressed the possibility of higher borrowing costs on December 1, will become a voting member next year.

Bernanke closed his last policy meeting of the year with core inflation higher than when he succeeded Alan Greenspan on February 1. The economy has slowed and the jobless rate surprised economists by dropping to 4.5 percent, from 4.8 percent at the start of Bernanke’s term.

Inflation has been stubbornly elevated based on the Fed’s preferred measure, an index tied to consumer spending minus food and energy. The core personal consumption expenditures price index rose 2.4 percent for the year ending October, above the tolerance zone of 1 percent to 2 percent stated by Bernanke and other officials.

The October reading was just below the 2.5 percent reported in August, the fastest pace since April 1995.

At the same time, the Fed’s pledge to keep inflation low has kept the longer-term outlook for prices stable. Traders expect inflation to average 2.44 percent over the next five years, according to yield differences on Treasury notes and government inflation-indexed bonds. That’s below 2.53 percent when Bernanke became chairman on February 1.

Some traders expect the Fed to cut its benchmark rate at or before the May 9 meeting, based on the price of interest-rate futures on the Chicago Board of Trade.

“The Fed is in a holding pattern,” said Jason Schenker, an economist at Wachovia Corp. in Charlotte, North Carolina. “They’re still concerned about inflation and those fears have not been assuaged.”

Policy makers may be waiting for results of the holiday shopping season to judge whether the housing and auto slumps are spilling over into the broader economy. Consumer spending accounts for about 70 percent of the US economy.

Bernanke, giving his most extensive remarks on the economy since July, said in a November 28 speech that “economic activity has, on balance, been expanding at a solid pace” outside of the housing and auto industries.