Greenspan says Fed to keep raising rates

WASHINGTON - Alan Greenspan, in one of his last appearances before Congress as Federal Reserve chairman, told lawmakers today the US growth outlook was solid and the Fed will keep lifting interest rates.

But he warned "significant uncertainties" confront this positive prospect, including high energy prices, labor costs, the future path of long-term interest rates and the danger this could spell for the country's housing market.

"Our baseline outlook for the US economy is one of sustained economic growth and contained inflation pressures," he told the House of Representatives Financial Services Committee in the first of two days of semiannual testimony on the economy and monetary policy.

"In our view, realizing this outcome will require the Federal Reserve to continue to remove monetary accommodation. This generally favorable outlook, however, is attended by some significant uncertainties that warrant careful scrutiny."

Stock prices initially softened but then pushed ahead, with the S&P 500 index, one of the broadest measures of US equities, pushing to a new 4-year high.

The dollar was also initially firmer and bond prices fell, although the currency subsequently drifted lower against the euro on technical selling while US government bonds won back lost ground in longer-dated maturities.

"The overall thrust of the remarks is that the expansion is nowhere near its later stages. The chairman's remarks show a remarkable amount of confidence in the economy's prospects," said Richard DeKaser, chief economist at National City Corp.

Interest rate futures, which are essentially bets on what the Fed is going to do, also gyrated as investors revised estimates of where the Fed will stop raising rates.

The Fed has raised rates in nine quarter-percentage point steps since June last year to 3.25 per cent and futures contracts imply a funds' rate of 4 per cent by year-end.

"There is nothing in the Chairman's sermon even remotely hinting that the Fed is close to being done in its current tightening program," wrote Merill Lynch North American economist David Rosenberg in a note to clients.

"WITHOUT PRECEDENT"

Explaining one of the main risks to the economy, Greenspan said the decline of long-term interest rates, which have stayed low in the face of rising official interest rates, was "without precedent" and warned their future behavior was critical.

Greenspan said some regional housing markets, stimulated by low borrowing costs, have become gripped by "speculative fervor" although he dismissed worries that a drop in housing prices could damage the broad economy.

The Fed said the bond yield decline is in part due to a worldwide glut in savings, a glut likely caused by insufficient global investment.

Another culprit, Greenspan said, is a perception in financial markets that economic risks have shrunk in the face of expectations the benign economic climate was here to stay.

He warned investors pinning their hopes on this scenario not to become complacent.

"History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress," Greenspan said.

"Such perceptions, many observers believe, are contributing to the boom in home prices and creating some associated risks."

Greenspan implied the upward movement in official rates would be gradual, citing the last Fed policy committee statement, which said rises would come at a "measured" pace.

While he said inflation remained well-contained, the 79 year old chairman said it was not clear if US unit labor costs would stay on their modest upward path and warned this could have an important impact on inflation.

A spike in oil prices above $60 per barrel along with other energy price rises posed another important economic risk.

"It is a shock. We do estimate a three-quarter-percentage point loss in real growth this year as a consequence of these prices," he told lawmakers during the prolonged question and answer session that followed his prepared testimony.

A flattening in energy prices would be good for inflation, but Greenspan noted that financial futures markets see little chance of a decline in energy costs "for years to come."

- REUTERS