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Interest rates may rise to curb inflation, Greenspan says

WASHINGTON—Federal Reserve Chairman Alan Greenspan said Thursday that the U.S. economy is on "reasonably firm footing" but signaled that he envisions further interest rate increases to keep inflation under control.

Testifying before the Joint Economic Committee of Congress, Greenspan said the pace of economic activity has alternately paused and quickened this year.

"The most recent data support the view that the soft readings on the economy observed in the early spring were not presaging a more serious slowdown in the pace of activity," Greenspan said.

However, imbalances and uncertainties remain, he cautioned. Those include yawning U.S. budget and trade deficits, slow wage growth, rising oil prices and concern that housing prices are overvalued across the nation.

The recent start-and-stop pace of growth can be explained in part by bouts of rising and falling crude oil prices. Despite today's once-again rising oil prices, Greenspan said, "the U.S. economy has done well, on net, by most measures."

Not well enough, apparently, to bring a pause in interest-rate hikes. Since last June, the Federal Reserve has raised short-term interest rates eight consecutive times in quarter-point hikes. The benchmark federal funds rate—the one banks charge each other for overnight loans and which the Fed sets—now stands at 3 percent.

Over the past year, Greenspan has taken pains to signal what's likely to happen next on short-term interest rates. On Thursday, he did so again, in the final paragraph of his prepared remarks.

He said the U.S. economy "seems to be on a reasonably firm footing, and underlying inflation remains contained." Then Greenspan reminded that in May the Fed had reaffirmed that interest rates could continue rising "at a pace that is likely to be measured."

Translation: Expect another quarter-point rate hike on June 30, the next time the Fed's policy-making body, the Open Market Committee, votes on rate policy.

Greenspan and colleagues are searching for a neutral zone for interest rates, where they aren't so high that they slow spending but aren't so low that they stoke inflation.

The Fed chairman devoted a large part of his testimony to the housing market. For the fifth straight year, housing prices are climbing steadily, leading to comparisons with the overvalued stock market in 2000.

Greenspan wasn't overly worried.

"Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications," he said.

Before the collapse of stock prices, Greenspan had famously warned of "irrational exuberance" in financial markets. On Thursday, he used tamer language for housing. He warned of signs of "froth" in some regional housing markets where housing prices may be unrealistically high.

"The apparent froth in housing markets may have spilled over into mortgage markets," the chairman said.

However, he said he worries about the recent dramatic increase in interest-only and exotic adjustable-rate mortgages. These allow consumers to live beyond their means and "their use is beginning to add to the pressures of the marketplace."

"This looks to us like a clear warning that the Fed and other regulators will soon work to limit such lending," said Mark Vitner, a senior economist for Wachovia, the banking giant.

Just days earlier, the Mortgage Bankers Association in Washington issued a less optimistic commentary.

"Fed Chairman Alan Greenspan has said on numerous occasions that home price increases nationwide do not constitute a housing price bubble. It's hard to argue with that conclusion," the association said Monday.

"But," the association added, "there is little doubt that home prices in numerous metropolitan areas are rising at rates that are unsustainable. At some point, the home price rise in many of these cities will come to an end. The only question is when, how and with what damage to the national economy."

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(c) 2005, Knight Ridder/Tribune Information Services.

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