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Fed hikes interest rates, voices inflation worries

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The Federal Reserve raised short-term interest rates by another quarter-percentage point Tuesday, expressing concern that a "solid" expansion is putting more inflationary pressure on the economy.

Although the quarter-point hike was widely expected, stock and bond prices fell sharply because the the Fed's statement announcing the decision implied the central bank might have to raise rates higher than many investors had expected. The Dow Jones industrial average lost 95 points or nearly 1 percent.

Fed Chairman Alan Greenspan and his colleagues continue to believe they can raise rates in a "measured" fashion, according to the statement. But the Fed expressed rising concern about inflation, saying that "pressures on inflation have picked up in recent months and pricing power is more evident."

"The Fed for the first time has really come right out and said, 'We're concerned about inflation,'" said Ethan Harris, chief U.S. economist for Lehman Bros. "We've been kind of been wondering about when they would acknowledge this creeping higher inflation, and here they have acknowledged it."

Harris said the statement increases the likelihood of "a whole bunch of more rate hikes."

It was the seventh straight time the Fed's Open Market Committee has held its regular meeting and decided to raise rates. The latest move pushes the benchmark federal funds rate to 2.75 percent, compared with just 1 percent last June, when it stood at a 46-year low.

Other short-term rates have moved higher in lock step with the benchmark rate including the prime rate, charged by lenders to many businesses and consumers. After the Fed’s move, leading commercial banks boosted the prime rate to 5.75 percent.

While the Fed voiced concern about consumer prices, it tempered that concern by commenting that a surge in energy prices over the past several months "has not notably fed through to core consumer prices." Crude oil has risen about 30 percent over the past three months, and gasoline prices have risen to a record national average of $2.11 a gallon.

But many analysts believe crude oil prices are rising largely because of speculative trading, and gasoline could be near a peak because of plentiful supplies, said Gina Martin, financial economist at Wachovia Securities.

With consumer inflation well-contained, the Fed should be to avoid a more disruptive half-point rate hike this year, she said.

"Honestly I think the Fed is in good position to do just a quarter-point (at a time) because as they say the consumer still isn't feeling the burn," Martin said.

But analysts are no longer expecting the Fed to pause in its rate-hike cycle anytime soon. If the Fed were to raises rate a quarter-point at every scheduled meeting this year, the federal funds rate, which banks charge each other for overnight loans, would end 2005 at 4.25 percent, the highest level in four years.

The Fed’s latest decision came a few hours after the Commerce Department reported that producer prices rose 0.4 percent in February, mainly because of sharp increases in the cost of food and energy. Without those two volatile categories, so-called core producer prices rose just 0.1 percent, although they have risen at a 4 percent annualized clip over the past three months.

The weak dollar is making it easier for domestic manufacturers to push through some of their increased costs to consumers, said Mark McMullen, a senior economist at “As pricing power improves, the additional costs created by higher input prices will increasingly be passed from firms to their customers,” he said in an online commentary.

What remains to be seen is whether the price of crude oil remains at or near the current level of about $57 a barrel, up more than 30 percent since December.

“There is nothing that suggests inflation is reeling out of control,” said Diane Swonk, chief economist at Mesirow Financial in Chicago. “My own feeling is that the oil price situation is a price bubble, but as long as it persists it’s going to be more of an inflationary concern than a growth concern for the Fed.”

Oil fell $1.43 to close at $56.03 a barrel in New York trading Tuesday.