WASHINGTON - The Federal Reserve, concerned that soaring energy prices could stoke broader inflation, boosted short-term interest rates yesterday and signaled that rates would probably keep rising in the months ahead.
Federal Reserve Chairman Alan Greenspan and his colleagues bumped up the federal funds rate by one-quarter percentage point to 2.75 percent and restated their intention to continue raising rates at a "measured" pace. The move was the seventh increase of that size since the Fed began tightening credit in June.
The Fed's latest rate increase came amid growing concern that inflation, fueled by soaring oil prices, is smoldering and could ignite.
In a brief statement after their meeting, the Fed policy-makers drew more attention to rising prices than they have in previous assessments, noting that "pressures on inflation have picked up in recent months and pricing power is more evident."
Still, they said the increases in energy prices haven't fed through to "core" consumer prices - those for a variety of goods excluding food and energy. And they said "longer-term inflation expectations remain well-contained."
Economists viewed the Fed's overall comments on inflation as slightly more hawkish and believed that they suggested further interest-rate increases well into the year. Some economists took them as a signal that a half-point rate increase could come next if the inflation outlook worsens.
"The Fed has provided itself with some additional flexibility in case they need it," said Lyle Gramley, a former Fed board member who's now senior economic adviser at Schwab Washington Research Group.
Steeper rate increases may follow later in the year, Gramley said, as higher oil prices, slower growth in productivity and the declining value of the dollar make an impact on the economy. "Threats like that can erupt into inflation," he said.
In response to the Fed's action, commercial banks began lifting their prime lending rates by one-quarter point to 5.75 percent. This rate, used for many short-term consumer and business loans, moves in lock step with the funds rate.
On Wall Street, stocks tumbled as the Fed's comments on inflation rattled investors. The Dow Jones industrials lost 94.88 points to close at 10,470.51.
The Fed is lifting rates as energy prices are climbing again. Oil prices, which set a record high last week, were hovering above $56 a barrel in trading yesterday. That's helping to propel gasoline prices sharply higher.
More expensive energy and food were the culprits behind wholesale prices rising 0.4 percent in February, the most in three months, the government reported yesterday. But core consumer prices inched up 0.1 percent.
For now, the Fed decided to keep language it has used with every rate increase, saying that future rate increases would occur "at a pace that is likely to be measured." Measured has come be to viewed as quarter-point bumps.
A few economists thought that language might be dropped at yesterday's meeting. Some believe it might be dropped at a subsequent meeting, perhaps at the next Fed gathering May 3 or the meeting June 29-30.
The Fed is expected to boost its benchmark rate to about 3.75 percent by year's end. Thirty-year fixed mortgage rates are expected to climb to perhaps 6.5 percent, up from just below 6 percent today, but still low by historical standards.
The funds rate is the interest that banks charge one another on overnight loans and is the Fed's main tool for influencing the economy. Before the Fed began its rate-raising campaign, the funds rate stood at 1 percent, a 46-year low. That extraordinarily low rate had been used to shore up the economy, which had struggled to recovery from the 2001 recession and the Sept. 11 terrorist attacks.
The way economic activity and inflation unfold in the months ahead, however, will ultimately shape the way the Fed acts.
"The Fed is saying we have a lot more work to do," said Ethan Harris, chief U.S. economist for Lehman Bros.
These days, the economic expansion is firmly rooted. The economy grew at a solid 3.8 percent annual rate in the final quarter of 2004, and analysts expect it to do as well or better in the current quarter.
Fed policy-makers said the economy "continues to grow at a solid pace despite the rise in energy prices, and labor market conditions continue to improve gradually."
Employers added 262,000 jobs in February, the most since October. Economists are hopeful payrolls will post sizable gains in the coming months, though they are concerned that might not occur if energy prices continue to surge and make businesses more cautious.
Even with the Fed's string of rate increases, longer-term rates, such as mortgage rates, have behaved relatively well. Economists expect that longer-term rates will rise gradually - rather than shoot up - in the months ahead.