Fed Lifts Key Rate, Confident In Growth

Some other committee members came to the meeting open to Olson's position; only seven of the 12 regional Fed banks had requested a similar quarter-percentage-point increase in the largely symbolic discount rate to 4.75 percent-- a sign that five Fed banks might have been content with no increase in the funds rate either. The discount rate is charged to commercial banks when they borrow directly from the Fed.

The federal funds rate influences many other borrowing costs throughout the economy. Major banks followed the Fed's action by lifting their prime rate on business loans by a similar quarter percentage point, to 6.75 percent from 6.5 percent. Many consumer rates, such as on credit cards and home equity loans, may rise as well. Banks and other financial institutions may increase the rates they pay on savers' certificates of deposit and money market funds.

However, long-term rates, such as those charged on 30-year mortgages, are determined by global markets. Those rates have remained low over the past 15 months, even as the Fed hiked short-term rates. For example, the fixed rate on a 30-year mortgage averaged 5.74 percent nationally last week, about where it was a year ago at 5.75 percent, according to mortgage finance company Freddie Mac.

The Fed committee made it clear that it plans to keep raising the federal funds rate in the months to come, repeating that it believes it can do so gradually, "at a pace that is likely to be measured."

Stock prices fell on concern that higher interest rates will dampen economic growth and profits.

Fed officials stressed their belief that the economy was in solid shape before the storm hit.

Consumers and businesses increased spending rapidly during the summer, while unemployment fell to a low 4.9 percent in August, and price inflation outside of the energy sector was tame.

The economy "appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina," the Fed statement said.

Fed officials did not mention it, but they are also well aware that the post-hurricane reconstruction will provide a strong stimulus to national economic growth. Insurance companies are preparing to pay about $50 billion in claims. Congress has appropriated more than $60 billion in assistance, and President Bush has proposed a federal response that could cost up to $200 billion by some estimates.

The result will be a net plus for the economy, according to estimates by Macroeconomic Advisers LLC, a St. Louis forecasting firm. The economy will grow by a healthy 3.4 percent in 2005, or roughly 0.2 percentage points slower than it would have without Katrina; the economy will then expand by a robust 3.8 percent next year, or 0.5 percent more than without the post-hurricane spending burst, the firm said yesterday.

The Fed's action was its 11th consecutive quarter-percentage-point increase in the federal funds rate, the overnight rate charged on loans between banks, since June 2004, when it was at a four-decade low of 1 percent.

Many investors and analysts have come to expect a "measured" pace to mean a quarter-percentage-point increase at every scheduled Fed meeting. But Fed officials have stressed that they could pause or increase the rate by as much as a half percentage point at a time, depending on the behavior of the economy.

Thus Fed policymakers might leave the fed funds rate unchanged at their next meeting Nov. 1 if the economy slows more than they expect. Or they could raise the rate by half a point if inflation takes off.

Several analysts predicted that Fed meetings will include more debate and possibly more dissents as the rate goes higher and as Greenspan prepares to step down early next year.

"Greenspan certainly has the intention of raising rates" higher, said Anthony Chan, senior economist for J.P. Morgan Asset Management. But, he said, "moving forward, there will be more challenges to that."