Greenspan Speech to Bolster Rate Hike View

Federal Reserve Chairman Alan Greenspan (search) will cement forecasts for higher U.S. interest rates when he speaks on Wednesday after August jobs data backed his view that growth is back on solid ground, economists said.  

Greenspan testifies on the economic outlook to the House of Representatives Budget Committee (search) at 10:30 a.m. in his only slated public appearance before the U.S. central bank's September 21 policy meeting, which is expected to weigh further rate hikes.

Analysts polled by Reuters on Friday were unanimous in forecasting a quarter percentage point rise that would take U.S. rates to 1.75 percent, as the Fed sticks to a campaign of gradual increases amid a widening economic expansion.

"He will indicate that the economy is still on a solid growth track and that the Fed will continue in a measured way to move interest rates up," said David Jones, head of consulting group DMJ Advisors.

Greenspan will also likely repeat his concerns about the risks an aging population poses to the country's social security safety net.

In addition, Democrats on the committee will aim politically loaded questions at Greenspan critical of President Bush's tax cuts and a massive budget deficit (search), which are hot topics as the presidential election race enters the last eight weeks.

PAY DAY

But financial markets will be tuned closely to the economic outlook, after a brighter August payrolls report on Friday supported Fed views that a soft patch seen in U.S. second quarter growth was temporary and has since recovered.

The Labor Department said 144,000 new jobs were created last month and June and July's numbers were also revised slightly higher, although job growth remained tepid.

Financial markets bet the U.S. central bank will raise rates at two of its next three policy meetings to take the target Fed funds rate to 2.0 percent by the end of the year.

But mixed data from big retailers like Wal-Mart and major auto makers warn the economy may not be entirely out of the woods and Greenspan will remain mindful of this threat.

"It appears that the pause was temporary and he will suggest that that is the case. But it is too early to declare victory," said Lynn Reaser, chief economist at Bank of America Capital Management in St Louis, Missouri.

Markets believe the Fed will put its tightening campaign on hold if the soft spot spills decisively into third quarter growth and this view has been stoked by Fed officials, who have signaled they will be flexible in reacting to the data.

Governor Ben Bernanke said on August 10 the Fed "has some scope to respond to the weakening of the economy associated with an oil price rise," provided inflation remains contained.

Sharp prices rises earlier in the year alarmed some Fed policymakers. But recent news has been more encouraging with the core measure of inflation faced by consumers, the PCE price index and one of the Fed's favorite price pressure measures, running at 1.5 percent year-over-year in July.

Greenspan will probably avoid speaking too emphatically of the recovery in order to preserve room for policy maneuver and because he does not want long-term market interest rates to rise too quickly in anticipation of future Fed action.

This could create unwelcome headwinds for the expansion, for example by undermining mortgage refinancing activity, which has been an important support for consumer spending despite the economy's at times disappointing record in creating new jobs.

"He is very worried that obsessing about inflation can knock the recovery off track," said Jones.