With its attention split between the lackluster economy and the confrontation with Iraq, the Federal Reserve’s rate-setting committee has elected to sit tight.

The Federal Open Market Committee maintained the federal funds rate at 1.25 percent. The panel said the economic outlook remains unchanged, with the risks balanced between inflation and anemic growth.

“In light of the unusually large uncertainties clouding the geopolitical situation in the short run and their apparent effects on economic decisionmaking, the Committee does not believe it can usefully characterize the current balance of risks with respect to the prospects for its long-run goals of price stability and sustainable economic growth,” the Fed announced. “Rather, the Committee decided to refrain from making that determination until some of those uncertainties abate.”

The statement is a sign that the Fed will keep a close eye on the economy and won’t stand by idly if things get worse.

The Fed probably believes consumer confidence will fall even more, and unemployment will rise, but things will improve within a few months, said Anthony Liuzzo, professor of business and economics at Wilkes University in Wilkes-Barre, Pa.

“The strength of the economy is manifest. We’re just going through a weak point right now,” he added.

The Fed has found itself in an awkward spot in the last few months. It has acknowledged that the economy is in what Chairman Alan Greenspan calls a “soft spot,” but blamed the economic lethargy on anxiety about Iraq (in Fedspeak, “geopolitical risks”).

As the pace of layoffs increased and consumer confidence went into freefall this year, the Fed insisted that its policy is “accommodative” — designed to stimulate the economy. Specifically, the Fed has tried to persuade businesses to hire workers and invest in new equipment. But businesses have locked their checkbooks away, waiting for the confrontation with Iraq to be resolved.

Speaking a few days before the meeting, National City economist Richard DeKaser said he expected the rate-setting panel to “spend a lot of time discussing the international situation — where does it fit vis-a-vis Iraq and Korea? I think they’re preoccupied with uncertainties related to war and where that’s headed in the next inter-meeting period.”

The committee’s next meeting is scheduled for May 6. That doesn’t mean the panel will wait until then if it decides another rate cut is needed. In 2001, the Fed made three rate cuts between meetings. One of those cuts came Sept. 17, six days after the terrorist attacks.

The federal funds rate is what Fed-member banks charge one another for overnight loans. It also is known as the overnight rate. The Federal Reserve sets a target for the overnight rate and controls it indirectly by adding and subtracting cash from the banking system.

The prime rate, which is what banks charge to their biggest customers, is 3 percentage points higher than the overnight rate. Some consumer rates are based upon the prime rate.

Long-term mortgage rates don’t necessarily follow changes in the federal funds rate. Instead, mortgage rates tend to move in the same direction as yields on Treasury notes, which in turn move up and down according to investors’ economic outlook.