Greenspan flies inflation warning flag

Alan Greenspan, the chairman of the Federal Reserve, yesterday cheered US financial markets with a broadly upbeat assessment of the American economy even as he raised a warning flag about his concerns that renewed inflationary pressures may be around the corner.

In a testimony on Capitol Hill, Mr Greenspan also defended comments he made in December about "irrational exuberance" in the US equity markets. The remark, which sent tremors through Wall Street at the time, "was not a shot from the hip", he insisted. The performance of the markets, he said yesterday, remained "breathtaking".

Translating Mr Greenspan's words as favourable news, investors yesterday gave a new lift to the Dow Jones Industrial Average which has continued to soar into record territory since the new year. After sagging more than 40 points at the start of trading, it closed up 40.03 at 6,883.90 after Mr Greenspan's comments.

Noting the continued stable growth of the US economy, Mr Greenspan told the US Senate that the economy "has retained considerable vigour, with few signs of imbalances and inflationary tensions that have disrupted past expansions". He reported that the economy grew about 3 per cent last year.

The chairman attributed the absence of inflationary pressure and low wage growth on several factors, in particular a continuing sense of job insecurity in the US workplace that was keeping wage pressures down. Among others were high US imports, increased deregulation, the declining influence of the unions and a sharp slowdown in the rise of healthcare costs.

There was a clear warning in his testimony, however, that wages could begin to succumb to upward pressures at any time, which could feed into higher inflation. "The recent pick-up in some measures of wages suggests that the transition may be already running its course," Mr Greenspan warned. The jobless rate in the US is at a seven-year low of only 5.3 per cent.

Mr Greenspan also reminded listeners that in setting monetary policy, the Fed always had to look roughly six months into the future. This was in part because there was always a time lag of about the same period before any interest rate adjustment began to bite.

That was taken by many analysts as a clear signal of the Fed's readiness to tighten monetary conditions at the first real sign of an uptick in wages and inflation. "Greenspan is clearly preparing the market for a possible tightening move. He leaves no question about that," said David Jones, an analyst with Aubrey Lanston.

The next meeting of the Fed's Open Market Committee, which sets interest rates, is scheduled for 3-4 February, by which time more data will be available to indicate whether new inflationary dangers are indeed gathering.

Addressing the extraordinary ebullience of Wall Street, Mr Greenspan remarked that the "stock market continued to climb at a breathtaking rate". He was forced on to the defensive about his "irrational exuberance" quip of last December by some aggressive questioning from senators.

"It was not a shot from the hip," Mr Greenspan said, explaining that he had been trying to lay out all the various factors that had to be taken into account by the Fed in determining monetary policy.

"We thought long and in detail that any such statement could very well have immediate market effects."