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Fed raises interest rates, warns of more ahead

The nation's central bank wants to slow the booming economy. As a result, consumers and businesses will quickly feel the effects on everything from home and car purchases to factory building.

Federal Reserve policymakers, intent on cooling off what in their view threatens to become an overheated economy, Wednesday raised short-term interest rates by a quarter-percentage point and warned that more moves may lie ahead.

With economic growth roaring ahead at nearly a 6 percent annual rate in the second half of last year, Fed officials are concerned the nation will eventually encounter shortages of labor or production capacity that will trigger more inflation.

Higher interest rates make borrowing more expensive for almost every purpose, whether to buy a home or car, build a factory or buy stocks. And Fed officials want to discourage enough borrowing to slow the economy's headlong growth.

In Wednesday's action, the central bank's top policymaking group, the Federal Open Market Committee, lifted its target for overnight interest rates to 5.75 percent following three similar increases last summer and fall. Separately, the Federal Reserve Board raised the discount rate, the interest rate financial institutions pay when they borrow directly from the Fed, to 5.25 percent from 5 percent.

Consumers and businesses will quickly feel the impact of the Fed's decision as financial institutions such as Bank of America Corp. and First Union Corp. begin raising their prime lending rate to 8.75 percent, the highest level for this benchmark consumer and business rate since late 1995. Many consumer loans, such as home equity loans and unpaid credit card balances, and most small business loans are tied to the prime rate.

In announcing its action, the Fed's Open Market Committee said it "remains concerned that over time increases in demand will continue to exceed the growth in potential supply, even after taking account of the pronounced rise in productivity growth."

Some analysts had said that economic growth has been so strong recently that the Fed might choose to raise rates by a half-percentage point this time instead of the more customary quarter point. And if officials didn't act more aggressively now, those analysts said, a larger increase would be likely at the next Open Market Committee meeting March 21.

However, Maury Harris, chief economist at PaineWebber Inc. in New York, noted that "the Fed chose to continue its usually gradualist policy of small, incremental changes." He predicted that officials will stick with that approach. Harris is looking for another quarter-point increase next month, but no more after that.

The PaineWebber forecast calls for only a 3 percent rate of increase in the nation's gross domestic product in the current quarter, which should make the Fed more comfortable about inflation pressures later this year, Harris indicated.

At Chase Securities in New York, economist James Glassman said the language of the announcement suggested that Fed officials "see nothing that has alarmed them except the ongoing strength in the economy since they met in December. They will stay with these gradual moves until they see demand slowing."

In contrast to the analysts who think the Fed will eventually have to increase rates by three-quarters of a point or more, Glassman, like Harris, thinks one more move in March might be enough.

"There'll be another step in March," Glassman said, "and my view is that they won't have to do more than that. But we will have to see how the economy unfolds."

Not everyone was happy with Wednesday's increase, much less the prospect of more later.

Jerry Jasinowski, an economist who is president of the National Association of Manufacturers, said that the Open Market Committee's decision was "premised on an exaggerated fear of inflation."

Jasinowski said that the uptick in inflation has been due to rising oil prices and has not been the result of more fundamental forces, such as accelerating increases in the cost of labor.

The Fed's move had little immediate impact on financial markets. The Dow Jones Industrial Average fell 37.85 to close at 11,003.20. The blue-chip index rose as much as 60 points in the moments before the Fed released its decision, then bobbed between positive and negative territory for much of the rest of the session.

The Standard & Poor's 500 slipped 0.16 to 1,409.12, and the Nasdaq Composite Index rose 21.98 to 4,073.96.

However, yields on many longer-term securities, including 10-year U.S. Treasury notes, had already risen partly in anticipation of the rate increase. The 10-year notes are a major influence on rates charged on 30-year fixed-rate home mortgages. Over the past two months, the national average interest rate on such mortgages rose about a half-percentage point, to 8.26 percent, according to Freddie Mac, the mortgage giant.

In related news, a key forecasting gauge rose to a new high in December, signaling that the U.S. economy's record expansion should continue well into the year.

The Conference Board said Wednesday that its Index of Leading Economic Indicators increased 0.4 percent in December to a record 108.7 after rising 0.3 percent to 108.3 the month before. That was in line with analysts' expectations. The index of leading indicators is a barometer of economic activity in the next three to six months.

_ Information from the Associated Press and Bloomberg News was used in this report.