The government Thursday predicted that the economy will grow at a larger-than-expected 3.5 percent rate in 1988 and that inflation will hold steady at 4.3 percent, with the odds overwhelming against a recession.

A slight increase in interest rates, about a half percent, was forecast for the year.In revising earlier estimates, Beryl Sprinkel, chairman of the Council of Economic Advisers, said, "Our rosy forecast wasn't rosy enough.

"The economy is doing better than even we expected."

The administration originally had predicted the economy would grow by 2.9 percent this year.

Sprinkel said the drought could have "a significant effect on food prices" unless there is rain soon. However, he said the farm community generates only about two percent of the Gross National Product, the broadest gauge of economic health.

Asked about the administration's new projections, private economist Michael K. Evans agreed with the upward revision in the economic growth prediction but disagreed with the inflation estimate.

"He's certainly right about better growth, . . . but the rest is just pie in the sky stuff," said Evans, a private economic consultant in Washington.

"We're not going to have double-digit inflation, but a reasonable private sector forecast of consumer inflation would be 5 to 5.5 percent," he said. "Nobody can be faulted for not forecasting the drought ahead of time, but now that it has occurred you have to make some upward revisions because of it."

Sprinkel released his new estimates at a White House briefing. Asked if the figures mean there is no chance of a recession, Sprinkel said, "I wouldn't say it's zero danger. Anything can happen.

"But it's our view the overwhelming odds suggest that the economy will continue to expand on average this year even though at a more moderate pace than was evident in the first quarter," Sprinkel said.

He said that, contrary to some fears, the economy is not overheating. Moreover, he said, "there is no sign of an upsurge in inflation."

Sprinkel said the economic growth rate would slow somewhat over the last nine months of the year from its first-quarter pace.

He said growth projections for 1989 and beyond were being revised downward slightly to offset the upward revision for 1988 and the stronger-than-expected growth experienced during 1987.

For 1989, the administration expects the economy to grow 3.1 percent. Economic growth is measured two ways, on an annual basis and on a fourth quarter to fourth quarter basis.