Greenspan warns next interest rate move likely to be up: Recent increase a form of low-cost insurance against inflation before pressures begin to emerg, Fed chairman testifies

ALAN Greenspan, the chairman of the US Federal Reserve Board, said yesterday that short-term US interest rates were likely to rise in the next few months but played down fears that inflation pressures were mounting.

Mr Greenspan told the Banking Committee of the US House of Representatives that the Fed's recent quarter-point increase in the federal funds rate, to 3.25 per cent, was a form of 'low-cost insurance' against future inflation pressures. In semi-annual testimony on monetary policy, he said: 'To promote sustainable growth, history suggests that real short-term rates are more likely to have to rise than fall from here.'

He warned that the Fed was obliged to act before inflation pressures began to emerge and policy was aimed at heading off a resumption of inflation in 1995. With no immediate evidence of an acceleration of inflation, 'we are focusing on 1995 and beyond. We want to make sure our monetary policy addresses that outlook'.

The Fed forecast inflation of about 3 per cent for 1994 against an annual rate of 2.7 per cent in December. Mr Greenspan said the consumer price index overstated inflation, but he warned that a 3 per cent inflation rate could not be considered stable.

The financial markets drew comfort from the Fed's forecast that a slowdown in the expansion was likely, suggesting that an imminent further tightening in monetary policy was not on the cards. The US central bank predicted that growth would ebb to a rate of 3-3.25 per cent in the year to the fourth quarter from the 7 per cent annual rate of growth estimated by many private analysts for the fourth quarter of 1993. Mr Greenspan predicted that this would lead to a renewed drop in long-term interest rates.

Led by the US treasury market, global bond prices rallied modestly and equity markets in Europe and the US adopted a firmer tone.

Mr Greenspan said that while the economy's forward momentum remained intact, the California earthquake and harsh winter weather might have dampened spending in January and February. The latest figures for US consumer confidence, released yesterday, showed a modest fall in optimism. Although the decline occurred from a high level, it reflected a sharp fall-off in positive expectations for economic conditions in the next six months.

But he added: 'We begin to see ever-increasing evidence that the economic recovery is increasingly entrenched' - despite the prospect of a temporary slowdown in housing construction and car sales. Growth of more than 3 per cent should lead to a further decline in unemployment.

He made it clear that the Fed did not regard rapid growth as the cause of inflation, but rather the excess credit that built up in its wake. The recent rise in short-term rates was meant to show that the Fed had 'no inclination' to supply excess credit this time around.