Fed Holds Rate at 2%

Updated from 2:17 p.m. EDT

The Federal Reserve held its key interest-rate target at 2% Tuesday, indicating that the central bank would rather continue its plan to fight inflation than provide much-needed liquidity to damaged credit markets.

The Federal Open Market Committee noted that strains in the financial markets have increased significantly and that labor markets have continued to weaken. Tight credit conditions, continued housing woes and some slowing in export growth should weigh on growth over the next few quarters. However, the FOMC reiterated its position that the economy will stay afloat with the initiatives already put in place.

"Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth," the FOMC said in a statement.

The FOMC added that inflation has been high, spurred by energy prices, and that it expects inflation to "moderate later this year and next year." However, the central bank noted that the outlook "remains highly uncertain."

The market was caught off guard by the Fed's decision to not cut rates, as the major averages fell to their lows of the session before spiking higher. It had been widely expected that the FOMC would cut the fed funds target rate to 1.75%, as fed funds futures had priced in a 100% chance of a 25-basis-point cut early Tuesday.

The Fed's decision to not lower rates comes during a time of turmoil for financial markets, including the failure of Lehman Brothers (LEH), which filed for Chapter 11 bankruptcy protection Monday, the surprise buyout of Merrill Lynch (MER) by Bank of America (BAC) and the potential collapse of AIG (AIG).