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Fed more concerned about inflation, increases interest rate

WASHINGTON—The Federal Reserve's policy-making body hiked overnight interest rates Tuesday by a quarter of a percentage point for the seventh consecutive time since last June and signaled increasing concern about inflation.

The action brought the benchmark federal-funds rate, which banks charge one another for overnight loans, to 2.75 percent. Commercial banks, led by Wells Fargo and Key Corp. of Cleveland, immediately pushed their prime lending rates up a quarter-point to 5.75 percent.

The Fed's latest rate increase came amid growing concern that inflation, fueled by soaring oil prices, is smoldering and could ignite soon. In a statement, the Fed's Open Market Committee said it thought its "measured" moves to restrain credit would contain inflation, though it said it would stay vigilant and respond as needed to maintain price stability.

"Though longer-term inflation expectations remain well-contained, pressures on inflation have picked up in recent months and pricing power is more evident. The rise in energy prices, however, has not notably fed through to core consumer prices," the Fed said.

Some economists took that as a signal that a half-point rate hike 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 hikes 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," Gramley said.

By saying it will maintain its "measured" monetary policy, the Fed repeated phrasing that's become synonymous over the past year with predictable quarter-point rate hikes to keep inflation in check. Many analysts had thought the Fed might drop the word "measured" to signal that it would raise rates more aggressively soon.

The economy has grown at a steady annual pace of 4 percent or so in recent months, while consumer price inflation has remained tame. Core wholesale prices—excluding volatile fuel and food prices—flattened to a weak 0.1 percent rise in February after a worrisome one-month blip of 0.8 percent in January, the government reported Tuesday.

Even so, analysts remain on guard against inflation.

Gina Martin, an economist with banking giant Wachovia in Charlotte, N.C., said people assumed that the Fed's "measured pace" meant rate hikes of only one-quarter percentage point, but that later moves easily could be twice that sharp if consumer prices jumped. Consumers power about two-thirds of U.S. economic activity.

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.

Fed Chairman Alan Greenspan seeks a "neutral zone" for the federal funds rate that neither sparks nor stifles the economy. Just where that neutral point is bedevils analysts.

"I think it is probably 4 to 4{ percent," said Richard B. Berner, chief U.S. economist for investment bank Morgan Stanley. "And given the inflation risks, in my view, it seems to be the Fed may have to adopt ... a somewhat restrictive monetary policy in order to keep inflation low."

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(c) 2005, Knight Ridder/Tribune Information Services.

GRAPHIC (from KRT Graphics, 202-383-6064): Interest rates

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