WASHINGTON – Federal Reserve (search) Chairman Alan Greenspan (search) said Thursday that the U.S. economy was on a "reasonably firm footing" while inflation was under control, a situation that will allow policymakers to raise interest rates at a measured pace.
In his first extensive comment on the economy since February, Greenspan warned the congressional Joint Economic Committee (search) about a possible housing bubble in some local markets but said the overall economy appeared healthy and would likely remain so.
Greenspan's generally upbeat assessment of the economy provided support for the view that the Fed, which has raised interest rates eight times over the past year, planned to continue nudging rates higher at a gradual pace.
"Despite some of the risks that I have highlighted, the U.S. economy seems to be on a reasonably firm footing, and underlying inflation remains contained," Greenspan said in prepared testimony.
"Accordingly, the Federal Open Market Committee (search) in its May meeting reaffirmed that it '...believes that policy accommodation can be removed at a pace that is likely to be measured,"' he added.
The Fed chairman repeated that while he did not think a nationwide housing price bubble was likely, there were signs of froth in some local markets where home prices have climbed to what appear to be unsustainable levels.
He said he was especially worried about the increase in riskier lending practices, which encouraged some households to buy homes they otherwise would not be able to afford.
"The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages are developments of particular concern," he said.
While analysts said Greenspan came closer in his testimony to calling the housing market a bubble, he maintained a sanguine outlook on the impact a drop in prices would have on the nation as a whole.
"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," Greenspan said.
Fed policymakers next meet on June 29-30 and it is widely expected that the Fed will raise a key short-term rate, the federal funds rate, by another quarter-point to 3.25 percent at that time. The Fed has raised short-term borrowing costs eight times since last June in a bid to head off inflation.
There had been some speculation that rate rises were nearing an end after Dallas Fed President Richard Fisher (search) used a baseball metaphor to suggest last week that the central bank was in the final stages of its tightening cycle.
U.S. Treasury prices eased initially and stocks and the dollar strengthened on Greenspan's closely watched testimony, which analysts said heralded a continuation in the Fed's rate-rise campaign.
"He's telling you that they're not going to stop tightening," said Steve Ricchiuto, chief U.S. economist at ABN AMRO in New York.
By late afternoon, the euro was down nearly 0.2 percent at $1.2215, while yields on benchmark 10-year notes fell back to about 3.95 percent after an earlier gain. The Dow Jones industrial average 26.16 points, or 0.25 percent, to end at 10,503.02. The Nasdaq Composite Index closed up 16.73 points, or 0.81 percent, at 2,076.91.
While Greenspan said a recent rise in hourly labor compensation was caused by a surge in bonuses and thus likely transitory, he noted that slower growth in productivity -- or hourly worker output -- was pushing up U.S. labor costs.
Businesses are having a harder time squeezing more output per hour from workers after several years of extraordinary productivity gains.
Greenspan said it was "an open question" whether businesses would be able to pass on these higher costs to consumers, fueling broader inflation, or be forced to cut profit margins.
Paul Ashworth, senior international economist at Capital Economics in London, said while high profit levels left some scope for businesses to absorb the higher price of labor, that would only offer a short-term buffer against inflation.
"If unit labor costs continue rising at this faster pace, consumer price inflation will accelerate well beyond what the Fed would be comfortable with," Ashworth said.
Reuters and the Associated Press contributed to this report.