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Fed Increases Key Interest Rate to 2.5%

'Measured' Raises Likely to Continue

By Nell Henderson
Washington Post Staff Writer
Thursday, February 3, 2005; Page E01

Federal Reserve officials raised a key short-term interest rate yesterday and indicated they will continue lifting rates gradually this year to keep inflation in check as the economy grows.

Members of the Fed's top policymaking committee unanimously agreed to nudge the benchmark federal funds rate up to 2.5 percent from 2.25 percent. It was the the sixth quarter-percentage-point increase since June, when the group started moving the rate up from 1 percent.

Post's Henderson on Fed's Decision
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Fed policymakers are generally upbeat these days, indicating in recent public remarks that they expect the economy to grow at a healthy pace this year while the job market improves and inflation remains tame.

With inflation low, Fed officials said they probably will keep raising the federal funds rate at a "measured" pace -- most likely in quarter-point increments over many months.

At 2.5 percent, the rate is so low that it is still stimulating economic growth, the Federal Open Market Committee said after the meeting in a statement nearly identical to one issued after its previous meeting in December. With the economy strong enough that it doesn't need an extra push, the Fed wants to raise the rate to avoid fueling inflationary pressures.

The group also repeated language emphasizing its willingness to accelerate interest rate increases if inflation pressures build or to move more slowly if the economy loses steam.

"The Fed's continuity suggests no plans to alter the thrust of its policy over the next few months," said Peter E. Kretzmer, a senior economist with Bank of America Corp.

The federal funds rate, the interest rate charged between banks on overnight loans, influences many other rates throughout the economy. Major banks followed by raising their prime rate for business customers by a similar quarter-point, to 5.5 percent. Many consumer rates tied to the prime -- including those on credit cards and home equity loans -- may rise as well.

Yet financial conditions have not tightened since the Fed started raising its rate in June for the first time in four years. Mortgage rates, for example, were slightly lower last week than they were last spring, according to Freddie Mac.

Longer-term rates are influenced by the federal funds rate but ultimately are determined by financial markets in response to the overall demand for capital and investors' inflation expectations. With that demand relatively mild and inflation expectations low, longer-term rates have not changed much.

But rates on mortgages and other loans should rise this year as the economy grows and the Fed increases the funds rate, analysts say.

Fed officials have not decided how far they will raise the rate this year and next. Several have said they want to move it closer to a "neutral" level that would neither spur nor slow economic growth, though they disagree about where that point lies.

Economists generally predict the Fed will raise the rate to somewhere between 3 and 4 percent this year, depending on how strongly the economy expands and how inflation behaves. Many analysts predict that the Fed will raise the rate again by a quarter-point at each of the next two scheduled meetings, in March and May.

Stock prices were little changed after the Fed's announcement, as it had been widely anticipated.

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