WASHINGTON (Bloomberg) - The Federal Reserve left its benchmark interest rate at two percent, ending the most aggressive series of rate cuts in two decades, as higher energy costs threaten to boost inflation.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the Federal Open Market Committee (FOMC) said in a statement yesterday in Washington.

Fed Chairman Ben Bernanke and his colleagues refreshed their forecasts at their two-day meeting and may have concluded the economy is likely to avoid a contraction. At the same time, crude oil prices have almost doubled in the past year and the cost of commodities from wheat to tin jumped to unprecedented levels.

"The Committee expects inflation to moderate later this year and next year," the Fed said. "However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."

Treasuries, which had fallen before the statement, dropped to their lows of the day. Two-year note yields rose to 2.96 percent at 2.19pm in New York, from 2.84 percent late yesterday. The Standard & Poor's 500 Stock Index was up 1.3 percent at 1,331.3. The dollar was little changed against the euro.

As policy makers convened, reports showed US home prices fell the most on record, consumer confidence touched a 16-year low, and durable goods orders were unchanged in May. Households are also falling further behind on their debt, eroding profits at lenders. Banks and securities firms have taken almost $400 billion in asset writedowns and credit losses.

"Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters," the Fed said.

Dallas Fed President Richard Fisher dissented from yesterday's decision, preferring an increase. He dissented against the rate cut at the April meeting.

Oil prices touched a record $139.89 June 16, extending a rally that helped push the consumer price index up 4.2 percent in May compared with an average rate of 2.7 percent over the past decade. Energy costs are hurting profits and household incomes, and raising expectations for future inflation.

Dow Chemical Co. said on Tuesday that higher raw materials costs will cause the company to raise prices by as much as 25 percent in July, following an increase of as much as 20 percent. United Parcel Service Inc. lowered its second-quarter profit forecast on June 23 because of rising fuel costs and slowing US growth.

American consumers foresee average annual inflation of 3.4 percent over the next five years, the highest expectation since 1995, according to the Reuters/University of Michigan survey.

"The risks of a sharp drop in activity have probably faded in their view," Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, said before the meeting. Without slack in the economy, "they would not be able to ride out the inflation wave."

Home prices in 20 US cities fell in April by the most on record, signaling the housing recession is far from over. The S&P/Case-Shiller home-price index dropped 15.3 percent from a year earlier. The gauge has fallen every month since January 2007. Employers have reduced payrolls for five consecutive months, helping push the unemployment rate to 5.5 percent.

Central bankers reduced the target rate for overnight loans between banks by 2.25 percentage points in 2008 with a series of aggressive rate actions, including two three-quarter-point cuts. In addition, the Fed invoked emergency authority in March to start lending directly to investment banks. The central bank also provided $29 billion of financing to secure JPMorgan Chase & Co.'s takeover of Bear Stearns Cos.

The financial system remains under stress. The Standard and Poor's Financials Index, which includes 90 bank, brokerage and insurance stocks, fell 21 percent from May 2 to June 24.

"Business conditions continue to weaken in the US and so far this month we have seen credit indicators deteriorate beyond our expectations," American Express Co. CEO Kenneth Chenault said in a statement yesterday.

Financing rates are also rising for consumers. The rate on a 30-year fixed-rate mortgage rose to 6.3 percent June 24 versus 5.79 percent at the start of the year, according to Bankrate.com.

"There has been some tightening of financial conditions over the past month," Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington, said before the rate decision. "That will certainly weigh on the outlook."

Fed officials discussed their new forecasts for 2008, 2009 and 2010 at the meeting. Mr. Bernanke will reveal the FOMC's new outlook for inflation, growth and employment in his semi-annual congressional testimony next month.

Wall Street analysts are divided on how higher energy costs may affect growth. The 38 percent rise in oil prices this year absorbs more consumer dollars, pulling spending away from other goods and services. If inflation is allowed to rise further, the purchasing power of incomes could fall. After tax incomes adjusted for inflation rose at a 1.8 percent rate for the 12 months ending April, versus 3.1 percent for the same period a year earlier.

The federal government has also injected $70.8 billion into the economy through tax rebates, which could lead to one or two quarters of stronger growth and add momentum to price increases.