The Federal Reserve Board may be far from finished raising interest rates despite its inaction last week, according to a careful watcher of the central bank.

"I think the Fed is still behind the curve on inflation," said Eugene J. Sherman, senior vice president and director of research at M.A. Schapiro & Co., New York.

Despite five pounds of credit tightening since February, "they are still only at about the middle of the neutral zone" on monetary policy, he said. "By this point they really should have moved to a modestly restrictive posture.

The Fed last elevated rates in August, but recent data showing new strength in the economy has spawned fresh inflation fears in the financial markets. Bank stocks have been particularly hard hit.

The American Banker index of the 225 largest publicly traded bank stocks has slumped 6% in the past month, a performance far worse than the overall stock market.

"The Fed held on to an accommodative monetary policy too long and allowed an inflationary condition to develop," he said last week. "Now it is pretty well cast in stone that we are heading toward a 4% inflation rate for 1994.

"The challenge from here will be for the Fed to hold inflation below 5% at the peak, which will probably be in 1997," Mr. Sherman said.

The economist now expects the Fed's policy-making Open Market Committee to lift both the federal funds rate and the discount rate by 50 basis points at its next meeting, on Nov. 15.

Mr. Sherman thinks there was dissension at the Open Market Committee meeting last Tuesday, with some members favoring a rate hike and other believing further evidence of the impact of previous increases is still needed.

The economist believes the committee granted Fed Chairman Alan Greenspan authority to lift rates prior to the November meeting if necessary, but that this is unlikely to happen because of the mid-term congressional elections on Nov. 8.

Why, despite rising economic activity at the end of last year, did the Fed hold off its initial credit tightening until last February?

Apparently the central bank's staff has "consistently underestimated the vigor of the economy," Mr. Sherman said.

When confronted by results stronger than anticipated by their forecasts the Fed's leadership has too often seen them as an aberration and waited for further data before acting.

The delays permit the inflation rate to gain momentum, he said. And once established, that momentum "is very difficult to reverse," usually requiring further hike in interest rates.

Tightening a further 50 basis points would only put the Fed's policy at the upper edge of neutrality. Mr. Sherman defines neutral policy as 1.5 points over the six month moving average of the core consumer price index, plus or minus 50 basis points.

The core index now stands at 3.2% on an annualized basis, making 4.75% the midpoint of neutral Fed monetary by Mr. Sherman measure.

That is also the current Fed funds rate.

Thus the Fed would have to tighten by 75 basis points, even a full percentage point, to enter the restrictive zone where the M.A. Schapiro economist think they belong.

But Mr. Sherman's views are not universally held. Some prominent Wall Street economists think the Fed has overreacted, with little or no likelihood of serious inflation on the horizon.

Among bank stock analysts, however, there is nearly complete agreement that banks will not handle further interest rate increases as easily as they did earlier this year.

"It's been a tough month," said Frank J. Barkocy of Advest Inc.

"Once again, there is a lot of uncertainty in the market about when the next rate increase is going to come, how much it will be, and how the banks will react."

"It almost makes you wish the Fed had raised rates again on Tuesday, just to clear the air," he said.

Previously, banks have matched the Fed's rate hike and their stocks have then rebounded.

In part, the bank's success was in being able to "drag their feet on the liability side," meaning they avoided raising the cost of deposits, while lending rates went up.

"That's not going to be the case next time," he said. "The pricing competition, particularly at the upper end of the lending spectrum, will make it harder for banks to aggresively raise the best rate, the prime rate.

Meanwhile, on the bank's liability side, "there has been growing pressure to raise deposit rates." Many of these rates are now significantly below market level.

"This is all going to have a crimping effect on the bank's [net interest] margins when it comes," he said.

Mr. Barkocy thinks strong and rising loan demand will offset some of this margin pressure, unless the Fed hikes rates sharply enough to curb the extension of new credit.

With the Fed not scheduled to weight action on rates again until mid November, the analyst thinks the bank stock market will stay "a little sloppy."

In the intervening period, third-quarter earnings results from the banks could provide a temporarily lift for their stocks, and the announcement of a major merger or acquisition deal could also revive investor interest.

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