WASHINGTON - Despite a government report yesterday confirming that the U.S. economy cooled during the first three months of the year, the bond market still expects Federal Reserve officials to raise short-term interest rates again in May.

The Commerce Department said in its advance estimates that first-quarter gross domestic product increased at an annual rate of 2.6%, below most Wall Street predictions and well below the 7% boomlet recorded during the last three months of 1993.

Clinton Administration officials hailed the GDP report as evidence that the economy continues to enjoy solid growth without any pickup in inflation. At the White House, Laura D. Tyson, head of the president's Council of Economic Advisers, said the report "should calm fears that the economy is growing at an unsustainably rapid rate or that inflation is about to spite upwards."

The Commerce Department's GDP price index for domestic purchases was up 2.3% in the first quarter, unchanged from the fourth quarter. The fixed-weight price index rose 2.9%, up from 2.3% but below the 3.1% rate for all of 1993.

Still, analysts said they believe Fed policymakers will lift the federal funds rate to 4% from 3.75% and raise the discount rate to 3.5% from 3% at the May 17 meeting of the Federal Open Market Committee.

"They're not doing it because of current conditions," said Gary Thayer, senior economist for A.G. Edwards & Sons Inc. in St. Louis. "They're doing it to position the economy for what might develop in the next year by establishing a neutral monetary policy. The economy doesn't need low interest rates any more."

Fed Chairman Alan Greenspan said that he and his colleagues have never defined their short-term goal of restoring a neutral monetary policy, but economists generally take it to mean a federal funds rate in the range of 4% to 4.5%.

"It's okay to be growing at this rate, but that doesn't mean the Fed shouldn't be raising interest rates," said Kevin Logan, chief economist for Swiss Bank Corp. Bond prices continued to be set yesterday with a built-in anticipation of another move soon by the Fed, he said.

The GDP report showed that the economy weakened considerably in most major sectors following the surge in growth during the last three months of 1993.

One area that contracted was government spending, which tumbled 6.25% or $14.9 billion. Federal purchases dropped 12%, led by a large decrease in defense outlays, while state and local governments that normally spend steadily chopped outlays 2.6%. The falloff in municipal outlays probably was the result of the harsh winter weather, which halted construction on many projects, analysts said.

Exports of goods and services fell 9.3%, reflecting weak foreign demand for U.S. products, while imports rose 2.8%. Overall, the drop in net exports took $19.7 billion out of the GDP accounts.

"Right now, the U.S. economy is capable of growing despite the large and growing trade deficit. But the U.S. cannot be the locomotive for a recovery in all the advanced economies," said Commerce Secretary Ronald Brown.

Rising interest rates and bad weather also took their toll, analysts said. Business investment in buildings shriveled 16.1% in the first quarter, while residential spending increased 9.1%, less than a third of the huge 31.7% increase recorded in the fourth quarter.

The one mainstay in the report was consumer spending, which typically accounts for two-thirds of GDP. It increased at a healthy rate of 3.8%, not far from the 4.4% gain in the fourth quarter. The gain came on continued strength in sales of autos and other durable goods.

Douglas Schindewolf, money market economist for Smith Barney Shearson Inc., said that in some ways the GDP report understated the strength in the economy because of the weather and evidence that growth picked up in March. "The momentum in the economy is still intact," he said.

Smith Barney economists have a 4% GDP forecast in place for the second quarter, but that may be revised to take into account the larger-than-expected rise in business inventories reported by the Commerce Department, Schindewolf said.

Business inventories gfrew by $30.5 billion in the first quarter, following an increase of $8.5 billion at the close of the year. However, analysts at Chemical Securities Inc. said the gain in inventories is not a problem because businesses were essentially building up stocks in response to higher sales.

"The key growth sectors of the economy - household spending and business investment - remain on strong upward trajectories," and will probably help fuel growth again that could be as high as 4.5% in the second quarter, the analysts at Chemical said.

Tyson said both the fourth-quarter and first-quarter GDP figures were distorted by special factors that included a rebound last year from the floods and drought of the summer, a rush by automakers to step up assemblies, and the cold weather.

For now, the administration is sticking with its forecast that U.S. output and inflation will both be up about 3%, Tyson said. Asked about the recent rise in interest rates, she replied: "It's too early to tell" about the impact on the economy.

Tyson declined to comment on Fed policy, but she said the administration and Fed officials share the goal or trying to get the economy to "glide into, or slow down," to its long-range growth capacity. Most economists say that would be growth of 3% or less. However, Tyson said, given the unemployment rate of 6.5% and slack resources in the economy, "for some quarters it can be above that."

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