US interest rates on hold until economic wounds begin to heal, says Greenspan

Global Economy: UK inflation tumbles to all-time low of 1.5% as Fed chairman issues gloomy appraisal

Fears of an imminent hike in interest rates on either side of the Atlantic dramatically faded yesterday as Alan Greenspan issued a gloomy warning, US stocks continued to suffer and inflation in the UK tumbled to a new all-time low.

Financial institutions in the City of London rushed to scrap their forecasts of an August rate rise, with some saying the cost of borrowing could be left on hold until 2003. One analyst even raised the prospect that the Bank of England could cut rates, a move that would take borrowing costs to their lowest level since 1955. Inflation tumbled to its lowest point for 35 years in June, according to figures published yesterday as shares in the UK recovered from Monday's 230-point drubbing.

In the US, Mr Greenspan, the chairman of the Federal Reserve Board, hinted he was not planning to increase rates because of the "lingering" impact of a string of corporate scandals and the crash in stock prices. He gave the markets a further jolt by warning that more corporate scandals could emerge, which could further undermine share prices.

The mixed messages unsettled Wall Street, where stock markets continued to plummet towards new six-year lows.

The blue-chip Dow Jones lost 1.9 per cent to close at 8,473.1, after another roller-coaster session. The markets see-sawed as traders tried to interpret Mr Greenspan's remarks.

The Fed bank chief said the economy had held up against corporate accounting scandals that had hammered the stock market. But he said these wounds may take time to heal, suggesting rates would stay on hold until that happened.

"While the economy has held up remarkably well, not surprisingly the depressing effects of recent events linger," he told Congress. He said consumer spending would be hit by the recent slump in stock prices and warned that worse could yet be in store.

"Considerable uncertainties ... about the potential for additional revelations of corporate malfeasance, and about possible risks from global political events and terrorism still confront us," he said.

"To be sure, previously undiscovered misdeeds will no doubt continue to surface in the weeks ahead as chastened CEOs restate earnings."

He said low inflation had given the Fed leeway to keep rates at a 40-year low of 1.75 per cent. He added that the US central bank had decided to maintain that loose policy until the economy was out of the woods.

"We have chosen to maintain that stance pending evidence that the forces inhibiting economic growth are dissipating enough to allow the strong fundamentals to show through more fully," Mr Greenspan said.

The Fed raised its forecasts for US economic growth to 3.5 per cent to 3.75 per cent this year, faster than the 2.5 per cent to 3 per cent growth central bankers had forecast in February.

Economists welcomed the testimony, saying Mr Greenspan had avoided starting a panic while also hinting that rates would stay on hold.

"The comments are very consistent with the Fed remaining on hold," said Alan Ruskin, research director at 4cast Ltd in New York. "The corporate misdeeds comment will be interpreted negatively by the equity market."

In London economists and investors scaled back their interest rate forecasts after the news inflation had tumbled in June.

The rate of inflation that the Monetary Policy Committee targets dropped to 1.5 per cent in June from May's 1.8 per cent. The headline rate fell to 1.0 per cent from 1.1 per cent.

The fall was steeper than expected and was driven by cuts in the cost of motoring and deep discounts on a wide range of household goods and clothes.

The target rate is the lowest since at least 1975, when modern records began, and according to an artificial index produced by HSBC is the lowest since 1967.

Crucially, it is a whisker above the level ­ more than 1 percentage point either side of the 2.5 per cent target ­ at which the Bank is forced by law to write a public letter of explanation to the Chancellor, Gordon Brown.

"With inflation so close to that level the MPC will find it hard to raise rates in the short term assuming it wants to," said David Hillier, chief UK economist at Barclays Capital.

Several other banks abandoned their forecast for a rate hike on 1 August and many now look for an increase in November, to coincide with the Bank's regular inflation report.

Some went further. Simon Rubinsohn, at fund manager Gerrard, said the Bank might hold fire until "well into 2003".

"The prospect of a more moderate economic performance next year allied to a flat inflation trend suggest rates will remain at 4 per cent for much longer than the market envisages," he said.

But the money markets swiftly followed suit with short-sterling contracts implying UK rates would end the year at 4.25 per cent compared with their current 38-year low of 4 per cent.

Just two months ago the markets were forecasting a leap in rates to 5.25 per cent to cool a booming housing market.

A survey from the surveyors trade body RICS tomorrow is expected to show that prices surged again in June, but the markets are unlikely to be too bothered.

"If you remove property from the equation I think the balance of the other data would be to lower rather than higher rates," said Dhaval Joshi, global strategist at SG Securities.

Analysts at The MarketPlace, an independent financial adviser owned by the bank Bradford & Bingley, said a rate cut was on the cards. David Bitner, its director, said falling inflation, weak GDP output, stock market falls and signs of a housing slowdown made a rate hike "increasingly remote".

"This combination of factors provides good reason for the Bank to try to stimulate the economy," he said.

Meanwhile, the London stock market gained a respite from its recent falls, posting its first gain in seven trading days.

The FTSE 100 closed 27 points higher at 4,021.9, regaining the psychologically important 4,000 level. The fightback was led by financial stocks amid heavy trading volumes.

Investors had to endure a roller-coaster ride as the blue-chip index veered between a gain of 85 points to a fall of 134 points before closing with small gains.