Oct. 20 (Bloomberg) -- Federal Reserve officials, satisfied that core inflation is slowly declining and likely to continue doing so, will make no change in their 5.25 percent target for the overnight lending rate when they meet next week.

The two-day Federal Open Market Committee session ending on Oct. 25 will be the third in a row at which the rate has remained unchanged following 17 consecutive increases.

A number of the officials have stressed in recent speeches that inflation is too high and that there is still a risk that it could accelerate rather than fall in coming months. Those statements caused investors to back off their expectation that the Fed was likely to begin to reduce the lending rate target in the next few months.

In a New York speech on Oct. 4, Fed Vice Chairman Donald L. Kohn said, ``that the odds favor a gradual reduction in core inflation over the next year or so, but the risks around this outlook do not seem symmetric to me: Important upside risks to the outlook for inflation warrant continued vigilance on the part of the central bank.''

Even so, Kohn and most other officials are comfortable with the current policy stance because it gives them the flexibility to raise or lower their lending rate target as economic developments unfold.

Which direction the next move takes -- and when it occurs -- may depend on how the spreading slowdown in the housing sector proceeds. That weakness, along with a drop in motor vehicle sales and production and a widening of the U.S. trade deficit, probably knocked economic growth down to a 1 percent to 2 percent annual rate in the third quarter.

Yellen Comfortable

In an Oct. 16 speech in San Francisco, Janet L. Yellen, president of that city's Federal Reserve Bank, said that ``the economy appears to have entered a period of below-trend growth. If this continues for a time, as I think is likely, the tightness we have seen in labor and product markets would ease somewhat, tending gradually to reverse any underlying inflation pressures.''

That's one of several reasons why she is comfortable with the FOMC's decision in August to stop raising rates, Yellen said.

``I do want to see inflation move down, but I believe policy may now be well-positioned to foster exactly such an outcome while also giving due consideration to the risks to economic activity,'' she said.

``We have yet to see the full effects of the series of 17 funds rate increases'' on economic activity, while the lending rate target is high enough that it ``is currently within the moderately restrictive range that appears appropriate,'' Yellen said.

Lacker Wants Increase

Not all Fed officials participating in next week's meeting are as sanguine about inflation as Kohn and Yellen. For instance, Jeffrey M. Lacker, president of the Richmond Fed, dissented at the last two committee meetings in favor of a quarter-percentage point increase.

Lacker apparently didn't challenge the view that inflation is likely to decline given the current level of the target. Rather, minutes of the Sept. 20 said, he ``dissented because he believed that further tightening was needed to bring inflation down more rapidly than would be the case if the policy rate were kept unchanged.''

Most other officials are more patient, thinking the most important thing is to be on a path toward price stability rather than trying to get back to that point rapidly.

For one thing, as the Sept. 20 minutes said, ``given the uncertainties in forecasting, significantly more sluggish performance than anticipated could not be entirely ruled out.''

Housing Drag

The future of housing is particularly hard to predict. Housing starts in September surprisingly rose almost 6 percent from August. Building permits, on the other hand, fell more than 6 percent last month and were almost 28 percent lower than in September 2005.

Housing construction is going to be a drag on the economy throughout the rest of this year and 2007 given the huge inventory of unsold new homes. ``For example,'' Yellen said in her speech, ``a major home builder has told me that the share of unsold homes has topped 80 percent in some of the new subdivisions around Phoenix and Las Vegas, which he labeled the new `ghost towns' of the West.''

The key issue for the Fed, though, is whether declining home prices will cause consumers to cut back on their spending as their housing ``wealth'' shrinks. So far there is no evidence of such a spillover from housing to the rest of the economy.

Lower Commodity Prices

Meanwhile, officials have been encouraged by the broad drop in many commodity prices, including oil and natural gas. Core consumer prices were up 2.9 percent in the year ended in September while falling gasoline and heating oil prices have lowered the 12-month change in the overall CPI to just 2.1 percent.

Nevertheless, lower commodity prices could help keep inflation expectations anchored, in part because the fall in commodity prices may be an indication of a better balance in supply and demand around the globe.

From the Fed's point of view, one could say, so far so good.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: October 20, 2006 00:05 EDT