The Civil Aeronautics Board said yesterday that the nation's airlines could raise domestic air fares by up to 5.4 percent beginning Thursday.

In another important aviation development, Midway Airlines announced it would begin discounted air service between Washington and Chicago's Midway Airport on June 1. Midway, which did not announce fares yesterday, is exptected to enter the market with four daily roundtrip flights with all seats, without restriction, priced somewhere between 25 and 33 percent below its major competitors' normal economy coach fares.

The CAB cited increases in both fuel and other costs in making its adjustment to the allowable fare level. Aviation fuel rose an average of 2.98 cents a gallon in March -- the smallest monthly increase since December -- but the average cost of a gallon of jet fuel stood at 85.79 cents at the end of the month.

Since last year, the CAB has been readjusting the fare level every two months instead of every six in order to help the airlines cope with rapidly rising fuel costs.

Yesterday's boost brings the fare ceiling to a level about 31 percent higher than it was a year ago.

The board said that a number of airlines already have fares as much as 3.5 percent above the current fare level -- using other provisions which allow them to raise fares by 5 to 10 percent above the fare level in various markets without CAB approval; if those airlines adjust their fares to the new level, their fare increases will be less than 5.4 percent, the board noted.

In its announcement on new services, Midway said it would begin service from Midway Airport to Minneapolis as well; Midway, the first airline formed under the airline deregulation act, has been offering lowfare DC9 jet service between Midway and Cleveland, Detroit and Kansas City since Nov. 1.