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Federal Reserve Raises Key Interest Rate 1/4 Point

Ben Bernanke, sticking with the Federal Reserve's playbook in his first meeting as chairman, boosted borrowing costs to a five-year high and hinted that an additional interest rate increase could be in store.

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Wrapping up a two-day meeting Tuesday, Bernanke and his Fed colleagues struck a mostly positive tone, saying the economy "rebounded strongly" in the January-to-March quarter from an end-of-year lull. But Fed policymakers raised concerns about the potential for inflation to flare up.

On Wall Street, stocks tumbled as investors expressed disappointment that more rate increases could be in the offing. The Dow Jones industrials lost 95.57 points to close at 11,154.54.

In a unanimous decision, the Fed raised its key interest rate — the federal funds rate — by one-quarter of percentage point, to 4.75 percent. This rate, which is the interest that banks charge each other on overnight loans, affects other rates charged to consumers and businesses.

Commercial banks reacted by lifting their prime lending rate — for certain credit cards, home equity lines of credit and other loans — by a corresponding amount, to 7.75 percent

Both the prime rate and the funds rate are at their highest since the spring of 2001.

Bernanke presided over his first meeting of the Federal Open Market Committee, the group that sets interest rates, and continued the gradual rate-raising campaign set in motion by his predecessor, Alan Greenspan.

It was the 15th such increase since the Fed started tightening credit in June 2004.

Some economists and investors hoped Bernanke would have indicated that Tuesday's increase was the last; he did not.

"The committee judges that some further policy firming may be needed" to keep inflation and the economy on an even keel, policymakers said in a statement after their meeting. That matched the language issued after the previous Fed meeting on Jan. 31 — Greenspan's last.

Attention now turns to the next meeting, on May 10.

"The statement suggests that we will see another rate hike in early May to ensure that the inflation genie stays in the bottle," said Lynn Reaser, chief economist at Bank of America's Investment Strategies Group.

"The Fed under Mr. Bernanke gave some fairly clear guidance that the Fed is not yet quite through raising rates. But we do believe there is a light at the end of the tunnel," Reaser said.

Many economists believe the Fed's rate-raising campaign will end this year.

Some predict a quarter-point jump in May, with the Fed then moving to the sidelines. Others believe the funds rate could rise to 5.5 percent by this summer before the Fed would stop.

The Fed is holding the door open to an additional increase because of concerns about inflation picking up.

An improving job market and stepped up production "in combination with the elevated prices of energy and other commodities have the potential to add to inflation pressures," policymakers said.

Thus far, "the run-up in the prices of energy and other commodities appears to have had only a modest effect" on the prices of most goods and services other than energy and food, the Fed said.

Until the Greenspan-led campaign, the funds rate stood at a 46-year low of 1 percent as the central bank sought to rescue the economy following the bursting of the stock market bubble, the 2001 recession, the Sept. 11 attacks and accounting scandals that rocked Wall Street.

With the economy back on its feet, the Fed has lifted rates back to more normal levels.

"Economic growth has rebounded strongly in the current quarter, but appears likely to moderate to a more sustainable pace," the Fed said Tuesday.

Analysts predict economic growth of 4.5 percent or higher in the current January-to March period. A slowdown in the final quarter of 2005 "seems largely to have reflected temporary or special factors," the Fed said.

Separately, Americans' optimism in the economy rebounded in March, climbing to a nearly four-year high.

The Conference Board reported Tuesday that its consumer confidence index rose to 107.2, compared with 102.7 in February.

Bernanke took over the Fed on Feb. 1 after Greenspan's 18-plus year run. Bernanke, who was an economics professor at Princeton and chairman of President Bush's Council of Economic Advisers, is leading the Fed at a time of concerns about the slowing housing market and bloated budget and trade deficits.

For now, though, Bernanke's message on the economy is mostly encouraging. "He's saying the economy is healthy. Inflation is OK for now, but it could become a problem, so we're not done raising rates yet," said Stuart Hoffman, chief economist at PNC Financial Services Group.

Click here to visit FOXBusiness.com's Economy page.