(…) Minutes of their January policy meeting, released Wednesday after the usual lag, showed officials agreed that the most likely next move will be an increase in an interest rate the Fed charges on emergency loans to banks, the discount rate, now at 0.5%.

Officials have emphasized that the point of such a move wouldn’t be to tighten credit broadly across the economy but to re-establish a penalty against banks that come to the Fed for emergency loans. Before the financial crisis, the discount rate was a full percentage point higher than the widely followed federal-funds rate, which is the rate banks charge each other for overnight loans.

The Fed made the penalty smaller during the crisis to help banks in need, but Fed staff recommended gradually increasing it. The first step would be to put the discount rate at 0.75%.

Officials are still debating many other moves, including when to begin tightening credit more broadly and how to reduce, over time, their $1.25 trillion portfolio of mortgage-backed securities.

The minutes also included updated forecasts by Fed officials that show them anticipating inflation-adjusted growth of between 2.8% and 3.5% in 2010 and 4% growth in 2011 and 2012. They expect inflation to remain subdued and the unemployment rate, now at 9.7%, to barely move for the rest of the year, then to drop to around 8.5% in late 2011 and to between 6.6% and 7.5% in 2012.(…)

Officials have said three conditions warrant keeping the "extended period" language in place: The economy is burdened by slack; market expectations for future inflation are stable; and current inflation is subdued. The minutes point to disagreement over two of those conditions—inflation expectations and the amount of slack in the economy.

Full WSJ article