Fed increases banks' interest rate 1/4 percent

Cost of short-term loans inches up to 1.75 percent

Change is third in 3 months

Panel sees slow rise continuing for next year


WASHINGTON - The Federal Reserve raised short-term interest rates another notch yesterday, and it suggested that it will keep raising them gradually over the next year.

The Fed, with its third rate increase in three months, pushed the benchmark federal funds rate on overnight loans between banks up to 1.75 percent from 1.5 percent.

The increase came less than seven weeks before the presidential election on Nov. 2. But while incumbent presidents normally cringe at the prospect of higher rates before an election, the increases are unlikely to pose any threat to President Bush because consumers and businesses have felt little if any tangible impact thus far.

Long-term interest rates, which drive home mortgage rates and many commercial loans, have actually edged down in recent months as fears of inflation have receded. And because this was the Fed's last policy meeting before the elections, consumers are unlikely to feel any more pinch from higher interest rates before the elections than they have already.

The main question ahead of yesterday's decision by the Federal Open Market Committee was whether the central bank would signal any change in its goal of raising rates at a measured pace of regular quarter-point increases over the next year. It did not, reiterating that "even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity."

If anything, the Fed expressed greater optimism about the economy than it did after its last policy meeting on Aug. 10.

More rises expected

"After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly," the Fed said in its statement. "Despite the rise in energy prices, inflation and inflation expectations have eased in recent months."

Yesterday's decision was widely expected, and the financial markets initially reacted calmly to it.

Most analysts believe the central bank will eventually raise short-term interest rates to at least 3.5 percent, and probably higher, in order to avoid provoking inflation in the future. Fed officials have made it clear that short-term rates, which were pushed down to a 46-year low of just 1 percent last year, are too low to be sustainable without provoking new inflation.

The "real" federal funds rate, after subtracting the effect of inflation, is still below zero and well below historical levels. That is a level of stimulus that Alan Greenspan, chairman of the Federal Reserve, has described as "increasingly unnecessary" to sustain an economic recovery.

Fed officials are tightening monetary policy at a moment when economic growth and inflation have been buffeted by the surge in oil prices this summer.

Consumer prices jumped at unexpectedly rapid rates last spring, prompting many analysts to complain that the Federal Reserve had kept interest rates too low for too long.

But just as the Fed was imposing its first rate increase on June 30, higher prices on gasoline and food caused consumers to pull back on spending. Economic growth slowed to an annual rate of only 2.8 percent, according to preliminary government estimates, and job creation slowed as well.

Regains traction

Just as Greenspan rebuffed many analysts by contending that the spurt in inflation stemmed from "transitory" factors like high oil prices, he predicted that the slower growth this summer would prove to be a temporary soft patch and told House lawmakers last month that the economy had regained traction.

The jury is still out on his prediction that the recent slowdown in growth would be temporary, but job creation and wages both climbed modestly in August and manufacturing activity remains fairly strong.

After its previous policy meeting on Aug. 10, the Federal Reserve said the economy appeared poised to resume a stronger pace of expansion. But many economists have trimmed their forecasts for growth in the second half of this year, from about 4 percent to 3.5 percent.

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