Greenspan To Consumers: Expect Higher Interest Rates

Federal Reserve Chairman Alan Greenspan put millions of borrowers on notice Thursday to get ready for an increase in interest rates. Many analysts expect the move - a pre-emptive strike against inflation - to come next Tuesday.

Financial markets, already headed lower because of interest rate fears, were jolted anew by Greenspan’s comments. The Dow Jones industrial average slid more than 57 points, partly because of the Fed chairman’s remarks.

Bond prices also headed lower but the dollar rallied on the prospect that higher rates will make the U.S. currency even more attractive to foreign investors.

In his testimony to the congressional Joint Economic Committee, Greenspan delivered his most direct and blunt warning that unexpected strength so far this year in the economy, coming at a time of tight labor markets, will trigger inflation down the road unless the central bank acts to head it off.

Greenspan stressed the “importance of acting promptly - ideally pre-emptively - to keep inflation low.”

The Fed chairman in two other recent congressional appearances has talked about dealing with inflation pressures before they actually cause higher prices, but analysts saw Thursday’s comments as more forceful because Greenspan specifically linked his concerns to recent reports showing unexpected strength in such areas as retail sales and job growth.

“If this isn’t the handwriting on the wall, I don’t know what is,” said Sung Wohn Sohn, chief economist at Norwest Corp. in Minneapolis.

“He is clearly signaling a tightening move at Tuesday’s meeting,” said David Jones, chief economist at Aubrey G. Lanston & Co. in New York.

The central bank’s rate-setting panel, the Federal Open Market Committee, meets next Tuesday, and many economists said they now expect a quarter-point increase in the Fed’s target for the federal funds rate, the interest that banks charge each other.

The Fed controls short-term interest rates by draining or adding reserves to the banking system. In recent years, any increase in the funds rate has resulted in an immediate hike by banks in their prime lending rate, the benchmark rate for millions of consumer and business loans.

The funds rate currently stands at 5.25 percent. The Fed hasn’t changed interest rates in more than a year, and it hasn’t raised rates since early 1995. The prime rate now stands at 8.25 percent.

Most analysts believe that when the Fed begins tightening credit, it will probably stop after two small quarter-point increases in the funds rate, enough to slow the economy and prevent overheating but not enough to push the country into a recession.

Lawrence Chimerine, economist at the Economic Strategy Institute, said the Fed will be making a policy mistake by raising interest rates, because it will drive the dollar even higher and worsen the nation’s trade deficit.

“There is no inflation to preempt,” Chimerine said.