The central bank stopped saying there is "accommodation" in its policy, a sign that members consider rates high enough that they're no longer spurring economic growth. The Fed qualified its pledge to raise its main rate at a "measured" pace, a phrase that has been in every interest-rate statement for 18 months.

"The committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance," the rate-setting Federal Open Market Committee said in its statement after meeting today in Washington. "Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained."

The FOMC's unanimous decision lifted the overnight bank lending rate by a quarter percentage point to the highest since May 2001. With today's language change, Chairman Alan Greenspan is revising the Fed's rate outlook less than two months before he retires and is leaving his successor, White House adviser Ben Bernanke, with a freer hand to set policy.

"It's a little too early to make the assessment that they are done," said Richard Volpe, head of government bond trading at Bear Stearns & Co. in New York, said in an interview. "We're still looking at a hike January 31, and our feeling as a firm is that we're also going to see a hike at the March 28 meeting."

Forecasts

The Fed is raising rates to keep energy costs, which rose after Hurricanes Katrina and Rita, from spilling into the price of other goods and services. The central bank has been trying to move its main rate to a so-called neutral level that neither spurs nor restrains economic growth.

"Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appeared solid," the Fed statement said. "Possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures."

All 100 economists surveyed by Bloomberg News predicted a quarter-point increase in the main rate. A separate Bloomberg survey from Nov. 30 to Dec. 8 showed economists expect the rate to rise to 4.75 percent by the end of the second quarter and then hold there for the rest of the year.

After today's announcement, traders in federal funds rate futures pared their bets that the rate would reach 4.75 percent by April. Traders now see a 56 percent chance. The benchmark 10-year Treasury note rose, pushing the yield down 3 basis points to 4.51 percent at 2:22 p.m. in New York.

Language Discussions

More than half of the primary dealers of U.S. government securities, including Lehman Brothers Inc. and Banc of America Securities LLC, predicted the central bank would stop saying interest rates provide "accommodation" today. All 22 expected the rate to increase to 4.25 percent, according to the Bloomberg survey of primary dealers.

Minutes of the last Fed meeting, which took place Nov. 1, showed that members discussed the need "before long" to change their outlook for the benchmark U.S. interest rate, with some worried about the risk of raising it too much. In a subsequent speech, San Francisco Fed President Janet Yellen said "accommodation" and "measured pace" were up for debate.

No Fed members have said publicly that they're concerned about raising rates too much. Chicago Fed President Michael Moskow said in a Nov. 21 speech that "an unexpected increase in inflation would be a serious concern," and his counterpart in St. Louis, William Poole, told reporters Nov. 9 that the risk of inflation is still "skewed toward the high side."

The Fed will release minutes of today's meeting Jan. 3.

Neutral Rate

Economists including Stephen Stanley of RBS Greenwich Capital in Greenwich, Connecticut, said the Fed may need to raise rates more than the so-called neutral rate to keep inflation under control.

"The implicit assumption is that once the Fed gets to neutral they'll stop," Stanley said before the decision. "Given a strong economy and increasing inflation concerns, everything is telling us they'll have to take policy to a restrictive stance."

Since the last meeting, government reports showed signs of slowing inflation.

The Fed's preferred measure for tracking prices, a Commerce Department gauge that excludes food and energy costs, rose 1.8 percent in October from a year earlier, the smallest gain in 19 months. Labor costs in the third quarter fell at a 1 percent annual rate after a 1.2 percent second-quarter decline, the biggest two-month decline since 2003.

Job Growth

Greenspan, in his most recent comments on prices, told Congress on Nov. 3 that there is "more uncertainty" about inflation than about the "longer-term prospects" for the economy, which "remain favorable."

The economy has showed few signs of slowing. The U.S. added 215,000 jobs in November, bouncing back from two months of weak job growth triggered by Hurricanes Katrina and Rita. The economy grew at a 4.3 percent annual rate in the third quarter, the quickest pace since the first three months of last year, the Commerce Department said last month.

"Despite the disruptions of Hurricanes Katrina, Rita, and Wilma, economic activity appears to be expanding at a reasonably good pace as we head into 2006," Greenspan said in a Dec. 2 speech.

Economic Indicators

The Commerce Department said today that U.S. business sales rose 0.8 percent in October, more than double the increase in inventories. That reinforces forecasts that companies will increase production in coming months.

Continued growth, along with measures showing how much businesses are paying for materials and services, are evidence of "still-elevated inflation pressures," Bear Stearns & Co. economists wrote in a Dec. 5 research note.

"Based on strong economic growth and rising inflation, our belief is that the Fed will continue to raise rates," said Conrad DeQuadros, a senior economist at Bear Stearns in New York, in an interview before the decision. "We have the Fed going to 5 percent by the middle of 2006."

More small businesses said they raised prices for the goods and services they sell, according to a report today from the National Federation of Independent Business. Twenty-six percent more firms said they intend to raise prices than plan to lower them, the second-biggest spread since the survey began in 1986 and up from 22 percent in October. The NFIB polled 532 firms.

Consumer Spending

Some economic reports remain mixed. U.S. retail sales rose 0.3 percent last month, less than forecast, the Commerce Department said today. Excluding gasoline and autos, retail sales rose 0.5 percent during the month, the smallest gain since July and half the October increase.

Fed policy makers are watching to see what effects higher heating bills and a cooling of the housing market will have on consumer spending and the broader economy.

Natural gas futures prices more than doubled this year as Katrina disrupted production along the Gulf Coast. Sales of previously owned homes fell a greater-than-expected 2.7 percent in October to the slowest annual rate since March. The number of unsold homes was the highest since April 1986.

Consumer Loans

Consumers' inflation expectations, another measure watched by the Fed, dropped last month as gasoline prices fell. People surveyed by the University of Michigan in December expected prices to rise 3.1 percent in the year ahead, down from 3.3 percent in November and 4.6 percent in October.

Changes in the federal funds rate can influence long-term rates on loans for homes and automobiles as well as securities such as Treasury notes and corporate bonds.

It's not a direct relationship, as the latest cycle of rate increases shows. The benchmark 10-year Treasury note has stayed below the 4.69 percent it reached the day before the tightening cycle started in June 2004, a phenomenon Greenspan called a "conundrum" in February.

The Fed's rate increases started to raise the cost of home loans in the past six months. The average rate on a 30-year fixed- rate mortgage, which is linked to the 10-year Treasuries, rose to 6.32 percent in the week ended Dec. 2, close to a three-year high, from 5.53 percent in early July.

The U.S. economy grew 3.7 percent in the third quarter from a year earlier, more than twice as fast as any of its European counterparts in the Group of Seven industrial nations. Growth was 2.8 percent in Canada and 2.9 percent in Japan on the same basis.