Fed raises key interest rate for sixth time

WASHINGTON — The Federal Reserve today raised interest rates for the sixth time since last June as policy-makers continued their efforts to make sure a strengthening economy does not trigger unwanted inflation.

The Fed announced that it was raising its target for the federal funds rate, the interest that banks charge each other, by a quarter-point to 2.5 percent. Before the Fed began tightening credit last June, the funds rate had been at a 46-year low of 1 percent.

The February increase is not expected to be the last. Analysts think the Fed will push the funds rate up in quarter-point increments through most of this year.

That would mean higher borrowing costs for consumers and businesses. The Fed's action today was expected to be quickly followed by announcements from commercial banks that they were raising their prime lending rates, currently at 5.25 percent, by another quarter point as well.

In explaining its action, the Fed repeated a previous promise that it believed it would be able to raise rates at a "pace that is likely to be measured."

Analysts believe the Fed will keep raising rates in small quarter-point steps as long as there are no signs that inflation is becoming a problem.

Wall Street took the widely anticipated Fed action in stride. The Dow Jones industrial average, which had been up for the day, remained in positive territory after the mid-afternoon Fed announcement.

"What this says in a nutshell is that the economy is right where the Fed wants it to be," said David Jones, head of DMJ Advisors. "Inflation is contained and the Fed is happy about that."

Consumer prices rose by 3.3 percent last year, compared to a 1.9 percent rise in 2003. It was the biggest annual increase since 2000, but it was driven by a surge in energy prices. Inflation pressures are expected to moderate this year, helped by an expected continued decline in global oil prices.

The Fed's goal is to move the funds rate from an accommodative stance, where it is still stimulating extra economic growth, to a neutral stance where the funds rate is neither stimulating growth nor holding the economy back.

"The Fed is taking its foot off the accelerator without hitting the brakes," said Richard DeKaser, chairman of an American Bankers Association panel of economists that meets twice a year with Fed policy-makers to give them their views of where the economy is headed.

There is debate in economic circles about where the neutral level is, but many economists believe it is somewhere between 3.5 percent and 4.5 percent for the federal funds rate.

If the Fed keeps increasing rates by a quarter-point at each of the eight scheduled meetings this year, the funds rate would be at 4.25 percent at the end of this year, a level where many analysts believe Greenspan will feel good about stepping down in January 2006 when his term as a Fed board member ends.

Financial markets became worried about the possibility of a more aggressive Fed stance in early January when a reading of the minutes of the Fed's Dec. 14 meeting seemed to indicate growing worries about inflation inside the Fed.

But in recent weeks various Fed officials have given speeches in which they have gone out of their way to stress that they do not believe inflation is getting out of hand.

Economists are split on how high interest rates will go. Some believe the funds rate will end the year at 4.25 percent while others think if inflation pressures remain contained, the Fed may skip raising rates for a meeting or two.