Fed Lifts Key Rate To Curb Inflation

More Hikes May Come, Policymakers Signal

Federal Reserve officials yesterday raised a key short-term interest rate for the first time in four years and signaled that they would probably nudge rates higher as the economy grows stronger.

Rate increases could become more aggressive if inflation pressures continue to build, officials indicated. But in a statement issued at the conclusion of their two-day meeting in Washington, the policymakers said they can raise rates "at a pace that is likely to be measured," because they expect inflation to remain "relatively low."

The 12 members of the Federal Open Market Committee voted unanimously to lift their target for the federal funds rate -- which influences borrowing costs throughout the economy -- to 1.25 percent from 1 percent, where it had been for the past year. Financial markets had little reaction to the afternoon announcement of the rate increase, which had been widely expected. Stock and bond prices rose slightly.

The Fed is raising the rate not to slow the economy, but rather to ensure that it does not grow so rapidly that inflation takes off.

The action "should not be interpreted as an attempt to brake an out-of-control economy," said Richard A. Yamarone, director of economic research at Argus Research Corp. He said the rate increase is "more appropriately analogous to taking the foot off the accelerator."

The Fed committee emphasized that it is prepared to abandon its plan for small rate increases, of a quarter-percentage point at a time, if its tame forecasts of "underlying inflation" -- which excludes volatile energy and food prices -- prove to be wrong. In the statement, the officials said the Fed "will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."

The statement effectively warned financial markets that the Fed must have flexibility to respond to changing conditions in an economy still in transition from a wobbly recovery to a sustained expansion.

If inflation pressures pick up, the committee could raise rates more frequently, or in larger increments than implied by a "measured pace." If economic growth falters and inflation falls to dangerously low levels, the committee could stop raising its target for a while, or even lower it again in response to an economic shock, such as a stock market crash or terrorist attack.

Because Fed officials have signaled for a while that they would start raising their rate target gradually, many borrowers are already paying higher rates and are likely to see rates continue to climb for a while.

The Fed funds rate, charged on overnight loans between banks, influences other interest rates determined by banks and financial markets, such as those on mortgages, credit cards, home-equity loans and other forms of household and business borrowing.