Federal Reserve Chairman Alan Greenspan said a recent slowdown in consumer spending because of inflation "should prove short-lived" and that the central bank can continue to raise interest rates at a "measured" pace.

"Inflation also seems to have been boosted by transitory factors such as the surge in energy prices," Greenspan told the Senate Banking Committee. "Those higher prices, by eroding households' disposable income, have accounted for at least some of the observed softness in consumer spending of late, a softness which should prove short-lived."

The Federal Open Market Committee, in a related report, predicted the economy will grow as much as 4.75 per cent in 2004 from last year's fourth quarter, down from a 5 per cent estimate in February. Retail sales and industrial production fell in June, job gains trailed forecasts, and a report yesterday showed an unexpected drop in housing starts. Stocks and bond prices fell.

At the reduced rate, GDP growth still would be the strongest since 1999.

"The expansion has become more broad-based and has produced notable gains in employment," Greenspan said. "If economic developments are such that monetary policy neutrality can be restored at a measured pace, a relatively smooth adjustment of businesses and households to a more typical level of interest rates seems likely."

The FOMC predicted its preferred inflation measure, the personal consumption expenditures price index excluding food and energy, will rise to a range of 1.5 per cent to 2 per cent this year, and as much as 2.5 per cent next year. Yesterday's report was the first time the FOMC gave its forecast on a core basis, emphasizing the central bankers' view that volatile food and energy prices skew the inflation outlook.

Market reaction

While the economy still has slack to help contain cost pressures, Greenspan said "we cannot be certain that this benign environment will persist, and that there are not more deep-seated forces emerging as a consequence of prolonged monetary accommodation."

The benchmark US 10-year Treasury note extended its loss, falling 3/8 point and pushing its yield up nine basis points to 4.44 per cent at 5:32 pm yesterday in New York. The dollar rose by the most in three weeks against the euro, climbing to US$1.2330 as of 5:08 pm yesterday in New York from US$1.2444 late Tuesday.

"Nothing is frightening them that growth will stall out or that inflation is getting out of hand," said James Paulsen, who oversees about US$125 billion as chief investment strategist at Wells Capital Management in Minneapolis. "The big message is that they're no more bullish or bearish about their rate path than when they started raising rates."

Faster if needed

The Fed raised the overnight bank lending rate last month for the first time in four years, by a quarter point to 1.25 per cent, and said more increases may come at a "measured" pace if inflation stays tame.

Greenspan reiterated that today as well as a pledge to raise rates more aggressively if necessary. Investors have already adjusted market yields and portfolios of mortgages and other assets in anticipation of higher rates, he said. Another 25 basis point increase is expected at the August 10 meeting, based on the median forecast in a Bloomberg News survey.

"Even if economic developments dictate that the stance of policy must be adjusted in a less gradual manner to assure price stability, our economy appears to have prepared itself for a more dynamic adjustment of interest rates," Greenspan said.

Based on yesterday's forecast, that trigger may be if the PCE excluding food and energy exceeds 2 per cent, said John Ryding, chief US economist at Bear Stearns & Co in New York. He referred to that level as the "inflation DMZ," or demilitarized zone, "between gradualism and more aggressive policy moves."

"We expect that core inflation will eventually move above 2 per cent and that the Fed will switch to more aggressive rate hikes," Ryding said. "However, at this point, we do not believe that this will occur before early 2005."

In February, the members predicted a PCE range of 1 per cent to 1.5 per cent, with a central forecast reaching 1.25 per cent. That forecast included food and energy prices.

(China Daily 07/22/2004 page12)