Economics The week in view: Fed may hold back on rate rise

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The Independent Online
Global investors have probably been let off the hook. Federal Reserve chairman Alan Greenspan suggested last week that the US central bank may leave interest rates unchanged at its next policy meeting in less than two weeks - though it is poised to raise rates in the months ahead if the US economy doesn't slow.

"1997 is not 1994" when the Fed began a series of seven rate increases, he said. "Current financial conditions are much less accommodative than they were in 1994" and there is "scant evidence of any imminent resurgence of inflation".

Greenspan also offered an unusually blunt defence of the Fed's decision to raise the bank lending rate a quarter point in March, chiding his critics for attacking what he called a "small prudent step" needed to ensure the continuation of a seven-year economic expansion.

With inflation low, Fed policymakers may be willing to wait for further evidence that demand is weakening from the first quarter's white-hot 5.6 per cent pace before acting again, the Fed chairman suggested.

In addition, unexpectedly high rates of productivity growth suggest rising wages may not push consumer prices higher, Greenspan said. And he said increases in bond yields and other market interest rates since early this year should already be slowing the economy to a pace that keeps inflation in check. "There are many reasons to be optimistic about the economy's prospects," he added.

Even so, a shoot-out still could occur at the 20 May meeting of the policy- setting Federal Open Market Committee if some officials push for an immediate rate increase - especially if two key measures of growth yet to be revealed show the economy is still expanding. The Commerce Department's April retail sales report comes on Tuesday and the Fed's own industrial production and capacity utilisation report will be out on 15 May.

Still, while Greenspan has only one vote on this panel, his position usually holds sway. And he also signalled in his speech that he wouldn't hold off for long. "Should the expected slowing in the growth of demand fail to materialise, we would need to address any emerging pressures in product and credit markets," he said.

It's still a close call, though, for the FOMC to wait until its 2 July meeting before deciding whether higher borrowing costs are needed.

Greenspan suggested as much when he noted that the nation's jobless rate fell to an almost quarter-century low of 4.9 per cent in April. "Falling unemployment rates and rising overtime hours - as well as anecdotal reports - unambiguously point to growing tightness in labour markets," he said.

In addition, "while there is scant evidence of any imminent resurgence of inflation... there also appears to be little slack in our capacity to produce".

Greenspan's remarks are highly unusual for the normally reticent Fed chairman. However, he's recently been more vocal in offering his opinions about the direction of, and dangers to, the economy.

In December, he sent markets reeling when he questioned how Fed policymakers would know if there was "irrational exuberance" in financial markets that could lead to a speculative bubble. He has since raised the same warning in congressional testimony, even as the US stock markets have continued to set records. Copyright: IOS & Bloomberg