Fed Raises Rates by 1/4 Point to 3%

WASHINGTON – As expected, the Federal Reserve (search) Tuesday raised its bellwether federal funds rate target by a quarter-percentage-point to 3 percent from 2.75 percent, its eighth increase in a row.

The decision by Fed Chairman Alan Greenspan (search) and the Federal Open Market Committee (search) is part of a credit-tightening campaign to bring rates back up to more normal levels.

Significantly, policy-makers repeated their expectation that policy stimulus can be removed at a gradual, or "measured," pace — wording generally taken to mean a diet of smaller, quarter-point hikes rather than bigger ones.

The move came as the central bank observes inflation pressures combined with a sudden slowing in economic growth.

Noting the recent slowdown, the Fed in its statement said, "Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices."

The Fed also noted rising prices, saying "Pressures on inflation have picked up in recent months and pricing power is more evident."

In what the Fed called an inadvertent mistake, it left out a follow-up sentence on inflation, stating, "Longer-term inflation expectations remain well contained."

It was widely expected that faced with those conflicting forces, the Fed would stay the course, raising interest rates marginally in an effort to keep inflation pressures from this year's spurt in oil prices from spilling into other sectors of the economy.

When the Fed started boosting rates 10 months ago, the funds rate stood at 1 percent, the lowest level in 46 years.

The increase in the funds rate was expected to trigger a corresponding quarter-point increase in banks' prime lending rate, the benchmark for millions of business and consumer loans. The prime rate now stands at 5.75 percent.

The outcome of Tuesday's meeting was a far cry from the expectations about the Fed's next moves that were being made immediately after its last meeting on March 22.

At that time, Wall Street began bracing for the Fed to ditch the promise to be measured and jack up rates by a half-point. That fear of more aggressive Fed credit-tightening was fanned by a change of wording in the March Fed statement to acknowledge more worries about inflation.

Since then, however, various indicators showed the economy slowing sharply in March. The government reported last week that this sudden slowdown had dragged down economic growth to a rate of just 3.1 percent in the first three months of the year, the slowest pace in two years.

That slowdown, however, eased fears for the time being about the Fed becoming more aggressive in its rate hikes. Analysts, however, are not looking for a pause in the gradual quarter-point increases because various inflation statistics are continuing to flash some warning signals.

Consumer prices jumped 0.6 percent, reflecting the surge in energy costs, but even outside of volatile food and energy, the so-called core rate of inflation was up 0.4 percent in March, the biggest jump in 2 1/2 years.

Many economists believe the Fed will keep raising the funds rate for the rest of the year with more quarter-point moves until it reaches a "netural" point for the funds rate, the level where the rate is neither stimulating economic growth or depressing growth.

The Fed has never said exactly where neutral is but many economists believe it could be around 4.25 percent, the level the funds rate would be in December if the Fed kept boosting rates by a quarter point at each meeting.

Reuters and The Associated Press contributed to this report.