Greenspan faces rates dilemma as markets hit by fresh turbulence

Fear stalked the US and European stock markets again yesterday. A drop in American unemployment to a 25-year low suggested that the turbulence in Asia's financial markets might not be enough to stave off a rise in US interest rates next week. Diane Coyle, Economics Editor, reports on the dilemma facing Alan Greenspan.

"The Federal Reserve cannot risk triggering a global stock market meltdown," said Brian Fabbri, chief economist for investment bank Paribas in New York. "I am absolutely confident it will not raise interest rates next week."

His confidence was not shared by all analysts, however. New figures showing the US unemployment rate at its lowest since 1973 and wage inflation heading up persuaded many that the odds on the Fed applying the economic brakes when it meets next week had increased.

Along with the earlier sharp drops in several Asian markets, this fear sent shares in Europe tumbling.

The FTSE-100 index ended nearly 100 points lower at 4,764.3, a 2 per cent drop. Earlier it had been 164 points down, below the 4,700 mark. Shares in Paris and Frankfurt lost 3 per cent by yesterday's close.

Across the Atlantic, the Dow Jones index fell 144 points before recovering some ground to stand 109 points lower at 7,564.62 by late morning. But the Treasury bond market shrugged off the evidence of inflationary pressure in the US economy as investors continued to see bonds as a safe haven from the turbulence in share prices.

Alan Greenspan, the Federal Reserve Chairman, offered little clue yesterday about his views on interest rate policy. Speaking in Frankfurt he said, enigmatically: "The Fed is struggling to find a firmer standard of monetary policy.... The focus on asset prices has become an increasing issue of debate at the Fed."

Christopher Low, an economist at HSBC Markets in New York, said: "If not for the `Asian flu', the Fed would be almost certain to raise rates next week. As it is, Mr Greenspan would undoubtedly stay on the sidelines for now."

But Stephen Lewis, chief economist at London Bond Broking, put the chance of an increase in rates at one in five. "The economy's growth rate will be near 4 per cent this year. It is clearly not sustainable," he said.

If the Fed does opt to raise rates next Wednesday, it would be the first increase since the quarter point rise to 5.5 per cent last March.

President Bill Clinton greeted the figures as evidence that the US economy's performance was the best for a generation. "The American economy has now added thirteen and a half million new jobs since 1993 while inflation has remained low and stable," he said.

Yesterday's figures showed a drop in the unemployment rate from 4.9 per cent to 4.7 per cent, the lowest rate since before the first Opec oil price shock. The number of non-farm jobs rose by 284,000, far more than expected, and September's increase was revised up to 269,000.

The tightness of the labour market showed up in an increase in hourly earnings to $12.41, up six cents from the previous month. The annualised rate of growth has accelerated to 5.6 per cent in the latest three months, indicating an upward trend in pay.

The increase in employment was spread across all categories - manufacturing, construction and government as well as services. There was also a small rise in the average work-week in industry to 42 hours.

"Businesses are bidding up for the available pool of labour," said Mr Fabbri.

The strength of the economy boosted the US dollar to its highest level against the yen for six months. It touched 124.22. the weakness of Japan's economy, particularly its financial sector, made the yen slide across the board.

The pound weakened slightly, its index against a range of currencies dipping 0.4 to 102.9.

But the main feature of the currency markets was a further rush to safe- haven currencies such as the mark and Swiss franc. "People are buying marks and Swiss francs when they see trouble in the stock markets." said Ernesto Ramirez, European economist at Bankers' Trust in London.

But the price of a former safe haven, gold, dived following Mr Greenspan's speech, which contained a long passage discussing how conventional measures overstated the true rate of inflation. The spot price of gold, a traditional hedge against inflation fixed at $308.70 in London, the lowest since July 1985.

The declines in shares in London yesterday were led by Asian-related stocks such as HSBC and Standard Chartered.

But the stock market was also affected still by the reaction to Thursday's quarter-point rise in base rates, a move that took many quarters of the financial markets by surprise. Analysts continued to debate how much higher the Bank of England might have to raise the cost of borrowing.

Richard Jeffrey at Charterhouse predicted that they could climb to 8.5 per cent because of the momentum of growth in the economy. Others warned that the Bank was in danger of looking too hawkish.