Updated from 3:09 p.m. EDT

The

Federal Reserve

made no change to its key interest rate target Wednesday, electing not to combat rising signs of inflation as the U.S. economy and financial system remain fragile in the midst of the housing and credit crunch.

As expected, the central bankers left the federal funds rate target at 2%, having lowered it by 325 basis points since last fall in hopes of stimulating a slowing economy and cushioning the effects of financial turmoil on Wall Street. The Dow Jones Industrial Average received a modest boost from the decision.

While the Fed took no action to combat inflation, it did sound a more hawkish note in its policy statement, suggesting that rate increases could be in the works later this year unless the economy deteriorates further.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased," the Fed said in its statement.

Still, the Fed reiterated its forecast that inflation will abate.

Cramer: Inflation, Blah, Blah, Blah

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"The committee expects inflation to moderate later this year and next year," the statement 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."

Peter Schiff, president of Euro Pacific Capital, says the Fed's inflation stance is probably all talk.

"In truth,

Fed Chairman Ben Bernanke simply wants to preserve the expectation that he will act, even if it is the last thing on his mind," says Schiff.

Only Dallas Fed President Richard Fisher dissented in favor of a rate hike, easing divisions on the committee between the Fed governors, which are appointed by the U.S. president, and the regional bank presidents. Philadelphia Fed President Charles Plosser sided with Bernanke's majority in a reversal from his dissents in two previous decisions.

Kurt Karl, chief U.S. economist for Swiss Re, said in a note to clients Wednesday that the U.S. economy is in a "mild recession or growth pause" and the Fed doesn't want to jeopardize a rebound by raising rates to fight inflation.

"The Fed will be on hold for a prolonged period due to the economic weakness, but will raise rates early next year when growth picks up," said Karl. "Currently, there is substantial monetary easing in the pipeline, which -- coupled with the weak dollar and ongoing fiscal stimulus -- should boost economic activity by late this year or early next year."

The Fed has drawn the ire of inflation hawks this year by lowering rates at a time when oil and gas prices are soaring and inflationary expectations are high. Now, fed funds futures show a greater likelihood of interest rate hikes from the Fed later this year than further cuts, but the presidential election looming in November and whatever additional fallout lies in store from the downturn in the economy could

complicate that outlook

.

Earlier on Wednesday, the Commerce Department reported that sales of new single-family homes fell 2.5% last month to a seasonally adjusted annual rate of 512,000, which brings the year-over-year decline to a stunning 40.3%. It also said orders for durable goods were flat in May, following a 1% drop in April.

The data followed Tuesday's report from the Conference Board that its consumer confidence index plunged in June to its lowest level since 1992. Economists worry that U.S. consumers are heading into a spending slowdown that could cripple economic growth.

The Fed has taken an increasingly activist role as the financial crisis has lingered. On Wall Street, the Fed in March rescued the fifth-largest U.S. investment bank, Bear Stearns, from bankruptcy and orchestrated its fire sale to

JPMorgan Chase

(JPM) - Get Report

. It also extended credit to other Wall Street firms and accepted mortgage-related debt securities of questionable value as collateral, crossing a line that has been in place for the central bank since the Great Depression.

Now, lawmakers are debating the regulatory implications of the Fed's actions at a time when vacancies on the Federal Open Markets Committee threaten to shift power to the central bank's more hawkish regional presidents, like Fisher and Plosser. Its recent actions have also been questioned by insiders like Richmond Fed President Jeffrey Lacker and former Fed Chairman Paul Volcker.

Meanwhile, the financial sector of the U.S. stock market remains a bloodbath.

Lehman Brothers

( LEH) shares have fallen 43% since the beginning of May, and the fourth-largest U.S. investment bank announced a second-quarter loss of $2.8 billion and said it will raise $6 billion in fresh capital.

Bond insurance giants

MBIA

(MBI) - Get Report

and

Ambac

( ABK) have lost their stellar credit ratings, signaling another potential wave of credit deterioration in the bond markets.