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Fed Chief Hints At Rate Hike

Federal Reserve Chairman Alan Greenspan told Congress on Wednesday that America's economic recovery has good momentum and that low, short-term interest rates will have to rise at some point, though he didn't say when.

"Looking forward, the prospects for sustaining solid economic growth in the period ahead are good," Greenspan said in prepared testimony to the Joint Economic Committee.

Greenspan, in striking an upbeat tone about the economy, noted a much-awaited improvement in the hiring climate after a long period in which an uneven economic recovery had failed to produce significant increases in the nation's payrolls.

But with the rebound in the economy, some companies are finding it easier to raise their prices, Greenspan said. He also noted that the fall in the value of the U.S. dollar and a strengthening global economy were adding to pricing pressures at home.

While stressing that inflation currently remains low, he said it was the job of the Federal Reserve to be stay on the alert for an unwelcome flare-up in inflation.

"As I have noted previously, the federal funds rate must rise at some point to prevent pressures on price inflation from eventually emerging," Greenspan said. "As yet, the protracted period of monetary accommodation has not fostered an environment in which broad based inflation pressures appear to be building."

Since last June, Greenspan and his colleagues have held the federal funds rate — a key short-term interest rate — at 1 percent, the lowest since 1958. Most economists believe the Fed will leave rates at that level at its next meeting on May 4.

Looking ahead, some economists predict the Fed will begin to push rates higher later this year. But others believe rates might stay where they are into 2005.

Greenspan's comments marked the second signal in two days that the Fed was beginning to edge closer to raising interest rates. Greenspan's remarks before the Senate Banking Committee on Tuesday sent stocks tumbling as Wall Street investors feared a rate increase would come sooner rather than later.

The Fed meets in two weeks to discuss monetary policy. Analysts expect the Fed's interest rate target to remain at a 46-year low at the May meeting, but many expect the FOMC to begin raising rates at its June or August meetings in response to a stronger economy, improved job growth and signs that inflation may have bottomed out.

Greenspan's comments "imply that Fed tightening could well occur sooner than many have been expecting," said Joshua Shapiro, chief economist for MFR.

In his testimony Tuesday on banking, Greenspan said the U.S. financial system is "strong and well positioned" to meet the challenges of higher interest rates.

Greenspan said U.S. banks weathered the shocks of the past three years quite well, posting high and often record quarterly earnings.

"Banks have made the most of the Fed's extremely low interest rates by providing all kinds of loans to consumers, especially mortgages. But as interest rates begin to move higher (over an unspecified time period), banks have adapted their portfolio of assets and business plans to benefit from higher rates, he said.

Greenspan said the performance of the banking sector during the recession shows the industry learned from the mistakes made in the late 1980s and early 1990s, when too much money was lent to real estate speculation.

"Better risk management has already begun to show real potential for reducing the wide swings in bank credit availability that historically have been associated with the economic cycle," Greenspan said. Keeping bank credit flowing is a primary goal of the Fed when it's trying to stimulate the economy during slowdowns and recessions.