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Fed lifts rate, says economy picking up

The Federal Reserve yesterday boosted its key interest rate for the third time in as many months, signaling the economy has rebounded from its recent struggles and inflation remains in check.

Policy makers voted unanimously yesterday to raise the federal funds rate to 1.75 percent, approving the third quarter-point increase since June, when the rate stood at a 46-year low of 1 percent. The federal funds rate is charged on overnight loans between banks, but it influences most other interest rates.

Consumers, already paying higher interest charges on credit cards, home equity loans, and other short-term borrowing, will see their rates go up again. On the other hand, interest paid on savings accounts should rise too. Since the end of June, for example, the average rate on a 1-year certificate of deposit has risen to 2.24 percent, from 1.48 percent, according to Bankrate Inc., which collects data on interest rates.

Meanwhile, long-term borrowers, such as home buyers, should see rates hold steady through the rest of the year since bond markets, which determine long-term rates, have already anticipated these moves and set interest rates accordingly. Mortgage rates, in fact, have slipped since the Fed started boosting rates as an improving inflation outlook has assured bond markets the Fed won't have to raise rates aggressively this year to keep rising prices in check.

The average rate for a 30-year fixed mortgage, for example, has fallen to about 5.3 percent from 5.9 percent at the end of June, according to Bankrate.

"The bond markets are feeling very comfortable and soothed," said Rick Fedele, the president of Summit Mortgage of Boston. "They know the Fed is on the attack, and inflation won't be able to run rampant."

Stock markets also were soothed by the Fed yesterday. The Dow Jones industrial average rose 40.04 points to close at 10,244.93. The technology heavy Nasdaq Composite index rose 13.11 points to close at 1,921.18.

With the rate increase widely expected, stocks rallied on the statement that was released with the Fed decision. In the statement, Fed policy makers suggested the economy, which stumbled this summer in the face of rising energy costs, had "regained some traction," and that inflation pressures had eased.

Many analysts have worried the recovery was sputtering in recent months, with both consumer spending and job growth slowing considerably. Job growth, in fact, nearly ground to halt in July, but rebounded in August to add 144,000 payroll jobs.

James Swanson, chief investment strategist at MFS Investment Management in Boston, said the Fed statement allowed him a "sigh of relief."

"The Fed is signaling that things are going very nicely," Swanson said.

Economists expect the Fed to raise rates at least once more this year, bringing the key rate to 2 percent. Some project the rate could rise to 4 percent by the end of 2005.

The rate increases are a product of an improving economy. The Fed cuts rates during recessions to stimulate the economy, and raises them when to economy grows to prevent runaway inflation.

In the wake of a recession, plus the shocks of 2001 terrorist attacks and the Iraq war, the Fed cut rates 13 times to their lowest level since 1958 to prop up the economy. Now that an expansion appears underway, the Fed will move steadily to wean the economy from low interest rates, analysts said.

The Fed's latest move comes just a few weeks before the presidential election. While Fed watchers say policy makers prefer not to act so close to an election, they have historically let economic conditions dictate their decisions. In 1980, for example, the Fed began raising its key rate in August, doubling it to 19 percent by year's end in an effort to squeeze out runaway inflation.

Then-President Jimmy Carter lost his reelection bid to Ronald Reagan that year.

Sung Won Sohn, chief economist at Wells Fargo Banks in Minneapolis, said the Fed had little choice but to raise rates yesterday since Fed officials, including chairman Alan Greenspan, have suggested to markets they would maintain their policy of raising rates gradually over the next several months.

"They've said it and they like to stick with it unless economic conditions change," said Sohn, "They don't want to surprise the markets."

Robert Gavin can be reached at rgavin@globe.com.

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