Federal Reserve officials, expressing confidence about the economy's strength and concern about price pressures, raised their key short-term interest rate yesterday and indicated they are likely to keep lifting it gradually higher to keep the lid on inflation.
"The expansion remains firm and labor market conditions continue to improve gradually," the central bank's top policymaking group, the Federal Open Market Committee, said in a statement after nudging its benchmark federal funds rate to 3.25 percent from 3 percent.
The group has raised the rate in nine quarter-percentage-point steps over the past year from a four-decade low of 1 percent. During that time, the economy has expanded at a healthy pace, while unemployment has fallen and price inflation for items other than energy has remained tame.
But Fed officials remain concerned about the potential for future inflation, citing rising labor and energy costs. They note that businesses are finding it easier to raise prices. And they are studying whether the nation's booming housing market is helping push up consumer prices.
"Pressures on inflation have stayed elevated," the Fed said, explaining its decision.
Stocks fell after the announcement, as investors concluded that short-term interest rates will keep rising for a while.
"There's nothing here to hint that the rate hikes might stop soon," Ian C. Shepherdson, chief U.S. economist for High Frequency Economics Ltd., wrote in an analysis of the Fed statement. "If anything, the hint is the other way."
Fed officials repeated that they probably can keep raising the federal funds rate, the overnight rate charged between banks, at a "measured" pace in the months to come.
After nine quarter-percentage-point moves, many investors have come to believe that "measured" means more of the same. But Fed officials say the language implies the possibilities of a half-point rate increase or a pause in the credit-tightening process, depending on how the economy performs.
The federal funds rate influences many other interest rates in the economy. Major banks followed the announcement by raising their prime rate on business loans by a similar quarter percentage point, to 6.25 percent from 6 percent. Consumer loan rates tied to the prime rate, such as those on many credit cards and home equity loans, may rise as well. Banks and other financial institutions may raise the rates they pay on savers' certificates of deposit and money market funds.
But longer-term interest rates, including mortgage rates, are determined by global financial markets and remain very low. The average rate for a 30-year, fixed mortgage fell last week, to 5.53 percent, the lowest level in 14 months, according to Freddie Mac, the mortgage finance company.
Meanwhile, the federal funds rate remains low enough to stimulate economic growth, the Fed noted, calling the level "accommodative."
The economy grew at a brisk 3.8 percent annual rate in the first three months of the year, the same pace as the previous quarter, even as the price of U.S. benchmark crude oil rose above $55 a barrel.
Even after oil prices topped $60 a barrel on Monday, many analysts forecast that the economy will expand by about 3.5 percent this year -- an above-average pace that should prompt employers to keep adding jobs.
But oil prices remain a wild card in the forecasts -- and in the Fed's calculations.
Consumer spending has swung up and down over the past year, as oil and gasoline prices have fluctuated. Higher energy costs leave households with less cash to spend on other items and cut into businesses' profits unless they are passed on through higher prices.
More recently, signs of weak consumer spending had encouraged some analysts to think the Fed might be nearing an end to its series of rate increases. For example, personal spending was flat in May after rising just 0.2 percent in April, after adjusting for inflation, the Commerce Department reported yesterday.
Household spending appeared to rebound in June, though the official figures will not be available for a few weeks. But gasoline prices climbed last month, which could dampen spending in July.
The national average price for regular gas was $2.22 a gallon yesterday, higher than a month earlier but down from a high of $2.28 on April 11, according to the AAA auto club.
Even so, Fed officials yesterday showed no worries about an economic slowdown and gave no sign they are close to finishing the job of raising interest rates.
Federal Reserve Board Chairman Alan Greenspan and others have said they want to move the federal funds rate to a neutral level that would neither spur nor slow economic growth. But Fed officials have not decided what that rate might be, agreeing only that it varies with economic conditions. Greenspan has declined to estimate the number, saying only that he'll know when he gets there because he'll see greater "balance" in the economy.
Other Fed officials and staff members have estimated that the neutral rate lies between 3.5 and 5.5 percent. Some central bank policymakers have argued that the neutral rate may lie near the low end of the range these days because the burgeoning trade deficit is exerting a heavy drag on economic growth. But others think it lies higher and are willing to overshoot if necessary to ensure inflation remains under control.
Consumer prices rose 2.2 percent in the 12 months that ended in May, according to a Commerce Department price index released yesterday.
Prices for items other than food and energy rose just 1.6 percent in the 12 months that ended in May -- well within the Fed's comfort zone -- according to the department's "core" price index, a measure preferred by Fed policymakers.
Fed officials also noted in their statement, reassuringly, that "longer-term inflation expectations remain well-contained."