Rates rise by one-quarter of a percentage point

WASHINGTON (AP) - The Federal Reserve on Wednesday raised interest rates for the first time in four years, reversing course as the economy strengthened. Policy-makers signaled only slow increases ahead in the rock-bottom rates Americans have enjoyed.

Wall Street rallied modestly on the Fed's continued promise of a "measured" pace for future rate increases as the Dow Jones industrial average climbed 22.05 points to 10,435.48. The muted reaction underscored the lack of surprise in what was the most telegraphed rate increase in Fed history.

Federal Reserve Chairman Alan Greenspan and his colleagues announced they were boosting the target for the federal funds rate by one-quarter of percentage point, to 1.25 percent. This rate, which represents the interest that banks charge each other on overnight loans, is the Fed's primary tool for influencing economic activity.

The Fed's decision triggered a one-quarter percentage point increase in commercial banks' prime lending rate, which also had not risen in four years.

This benchmark borrowing rate for millions of consumer and business loans rose from 4 percent, the lowest since 1959, to 4.25 percent. The prime announcements were led by U.S. Bancorp, Northern Trust and Wells Fargo.

Borrowers have seen the lows for mortgage rates and other loans. But economists said that rates for homes and autos should continue to be attractive, given the Fed's comments that it did not expect inflation to pose a problem soon.

The Fed reaffirmed a pledge, first made at its May meeting, that future rate increases would come "at a pace that is likely to be measured."

"The bottom line is that the Fed is going to continue to be cautious about hiking interest rates," said economist David Jones, author of several books on the Fed under Greenspan. "While we are seeing solid growth, we are not seeing an overheated economy."

Jones and other analysts said they read the pledge as indicating a series of one-quarter percentage point increases spread into next year.

Many economists are looking for the Fed to keep increasing the funds rate until it hits around 4 percent. At that level, analysts said, the Fed would view the rate as neither stimulating extra growth nor acting as a drag on growth.

The rate increases are expected to have little impact in slowing the economy before the November election. That would be good news for President Bush and other incumbents.

His spokesman, Scott McClellan, told reporters that rising interest rates were not a concern because rates are still at "historically low levels. The economy continues to be strong and grow even stronger."

Gene Sperling, an economic adviser to Bush's presumed Democratic rival, John Kerry, said the real threat to interest rates was not Fed action but Bush's tax cuts, which have caused the federal budget deficit to balloon.

"The real issue is that George Bush's abandonment of fiscal discipline will mean higher long-term interest rates, less sustainable economic growth and more debt passed on to our children," Sperling said in a statement issued by the Kerry campaign.

The Fed statement said that since its last meeting on May 4, the economy has continued to grow "at a solid pace and labor market conditions have improved."

The statement said that while "incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors."

This wording echoed comments Greenspan has made in recent speeches and in congressional testimony. He has said that he saw no signs, despite a temporary surge in energy prices, that inflation was becoming a problem.

But Greenspan also has said that if this view changed, the Fed was ready to raise rates more quickly. That sentiment was reflected in the Fed's statement, which said the central bank "will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."

If inflation remains moderate, analysts believe the Fed will move gradually to a funds rate of about 4 percent. Long-term rates, set by financial markets, also would climb. Analysts said some of these rate increases already have occurred, given that the Fed for several months has signaled its intention to start raising rates.

The nationwide average for 30-year, fixed-rate mortgages reached a low this year of 5.38 percent in mid-March, but was at 6.25 percent last week, according to the mortgage company Freddie Mac.

Sung Won Sohn, chief economist at Wells Fargo in Minneapolis, said he looked for 30-year mortgages to climb to 6.5 percent to 6.75 percent by year's end and probably level off slightly above 7 percent next year.

Still low by historical standards, that would compare with the four-decade low of 5.21 percent in June 2003.