Economy's rapid pace linked to Fed's May rate hike.

WASHINGTON -- Members of the Federal Open Market Committee, worried that the economy was growing too rapidly, voted 10-0 to raise short-term interest rates to 4.25% from 3.75% when they met May 17, according to minutes of the meeting released Friday.

The Fed officials agreed that broad measures of inflation remained subdued and that increases in labor costs had been moderate.

However, "they continued to be concerned that inflation could begin to rise if growth in excess of potential were to persist and margins of unutilized production resources were to shrink further, or even disappear," the minutes said. Most analysts do not believe the economy can grow above 2.5% to 3% without spurring price pressures.

The minutes said production "had already reached capacity limits in a number of industries," including motor vehicles and steel, and "prices of some raw materials and intermediate goods had risen substantially over the past year."

While some businesses have invested to expand capacity and hire additional workers, many "were taking advantage of opportunities to adjust prices upward," the minutes said. "There were also indications of shortages of qualified workers in some labor markets or industries," although wage pressures remained muted for the near term, the minutes said.

Fed officials indicated that they wanted "prompt action" to raise rates, with many commenting that the expansion "was on a solid and self-sustaining basis and appeared to have more underlying strength than they had foreseen earlier."

The officials said that the impact of low interest rates had become increasingly apparent in business investment and consumer spending on autos and other durable goods. The financial health of the banking system was described as "greatly improved" with both bank lending and demand for loans on the upswing.

The committee members retained a neutral policy directive, meaning it is not biased toward higher rates. However, Chairman Alan Greenspan has authority on his own to adjust rates in inter-meeting periods. The FOMC met again last week, and the bond market is expecting the Fed to tighten again soon following Friday's strong employment report.

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