Federal Reserve officials, citing recent signs of economic improvement, raised a key short-term interest rate yesterday for a third time this year and signaled that they are likely to raise it again before year-end to keep inflation tame.
Economic growth "appears to have regained some traction, and labor market conditions have improved modestly," the officials said in a statement issued after their meeting.
The Fed's top policymakers agreed unanimously to raise their benchmark federal funds rate by a quarter-percentage point, to 1.75 percent from 1.5 percent.
With the economy firming and the funds rate still very low, Fed officials believe they can continue raising the rate gradually, or at a "measured" pace, the statement said.
"There is nothing here to suggest they are prepared to stop" raising the rate soon, said William C. Dudley, chief economist at Goldman Sachs & Co. "Their reading is that the economy is all right and therefore the process of [raising] the fed funds rate should continue."
The Fed dropped the prediction made in its previous statement, issued after its Aug. 10 meeting, that the economy then appeared "poised to resume a stronger pace of expansion going forward."
That language, coming during the heat of a presidential race that may turn in part on the state of the economy, was quickly seized on by President Bush's campaign and e-mailed to reporters.
The Bush campaign declined to comment on the Fed's action yesterday, as did that of Democratic candidate John F. Kerry.
Fed officials nonetheless generally say they expect the economy to pick up more steam and grow at a healthy pace in coming months, which bolsters their case for continuing to lift the benchmark rate at a "measured" pace of quarter- or half-percentage point steps spread out over many months.
The Fed's action and statement yesterday "gave a vote of confidence for the economy," Sung Won Sohn, chief economist with Wells Fargo Bank, said in an analysis.
Financial markets showed little reaction to the Fed's decision, which was widely anticipated.
The Fed had lifted the funds rate, charged between banks on overnight loans, by a quarter-point each in August and June, after leaving it at an extremely low 1 percent for a year. The central bank had dropped it to that level, the lowest since 1958, to support the uneven economic expansion and to prevent deflation, a damaging fall in the overall price level.
The funds rate influences many other interest rates throughout the economy. Banks responded to the Fed action by raising their prime lending rate for business loans to 4.75 percent from 4.5 percent. Consumer rates that are linked to the prime rate, such as those on many credit cards and home-equity loans, will likely rise as much.
The Fed is not raising rates to slow the economy. At 1.75 percent, the benchmark rate is so low that it should still stimulate growth by encouraging businesses and households to borrow and spend, Fed officials say. But it is too low for a growing economy, they say, and could fuel inflationary pressures in the future.
"With the actual funds rate currently as low as it is, there is thus reason for a strong presumption that rates will need to keep going up as we move forward," Fed Bank of San Francisco President Janet L. Yellen said in a speech earlier this month.
Yesterday's Fed meeting was the last scheduled before the election. The central bank's top policymaking group is scheduled to meet two more times this year, in November and December. Analysts remain divided over whether the Fed will raise the rate by another quarter-point at one or both meetings.
Traders in futures contracts tied to the fed funds rate have priced them to reflect expectations that the Fed will raise the benchmark rate by a quarter percentage point in November, to 2 percent, and leave it there through December.
Yellen said in her speech that the Fed might have to raise rates more "aggressively" if inflation flared "significantly."
Alternately, she said, the Fed might rein in the pace of rate increases if the economy slowed. But she immediately added, "This concern seems less acute than it did a month or so ago."
While Fed officials generally remain upbeat about the economic outlook, they also say their forecasts of growth, inflation and job gains have been thrown off this year for a variety of reasons, including the substantial rise in oil prices.
Economic growth skidded in the April-through-June quarter to an anemic 2.8 percent annual rate, as oil and gasoline prices rose, job growth slowed to a near halt and retail sales fell. That was the slowest pace of growth in more than a year and well below the 4.5 percent annual rate of the first three months of the year.
Fed Chairman Alan Greenspan said in July that the economy had hit a temporary "soft patch." Then on Capitol Hill earlier this month he said he saw signs that the economy had rebounded a bit but was still being restrained by high oil prices.
U.S. benchmark crude for October delivery closed at $47.10 yesterday on the New York Mercantile Exchange, up 75 cents from the day before. Prices have eased slightly since their Aug. 19 high of $48.70.
But the Fed officials' action and statement yesterday indicate "the soft spot appears to them to be fading," Drew T. Matus of Lehman Brothers Global Economics wrote in a note to clients.
Fed officials may feel freer to pause at one of the upcoming meetings because inflation has receded since surging in the spring, some analysts said. According to the Fed's preferred measure of inflation, which excludes volatile food and energy prices, consumer prices rose just 1.5 percent in the 12 months that ended in July -- a low level and well within Fed officials' comfort zone.
"Inflation and inflation expectations have eased in recent months," the Fed said in its statement yesterday.
Staff writer Justin Blum contributed to this report.