Greenspan is skeptical of recovery

Fed chief hints more rate cuts could be coming

Major `risks' face economy

Weak profits, rising layoffs are among signs of slowdown

January 12, 2002|By BLOOMBERG NEWS

SAN FRANCISCO - An economic recovery that is just beginning may not have enough strength to endure, Federal Reserve Chairman Alan Greenspan said yesterday, suggesting to investors and economists that he remains open to cutting interest rates for the 12th time in 13 months.

"Despite a number of encouraging signs of stabilization, it is still premature to conclude that the forces restraining economic activity here and abroad have abated enough to allow a steady recovery to take hold," Green- span told the Bay Area Council Conference.

"I would emphasize that we continue to face significant risks in the near term," he said in the first speech on the economy he's given since October.

U.S. Treasury yields fell after the Fed chairman's remarks, which boosted investor optimism that policy-makers will leave their benchmark interest rate at a 40-year low of 1.75 percent, or perhaps even reduce it, when they meet at the end of the month.

"This is telegraphing that there will be another cut in interest rates," said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. "He sees the recovery proceeding in fits and starts rather than at a steady pace."

Business profits and investment "remain weak," Greenspan said. Rising unemployment and stock prices still below their highs of the past two years may restrain consumer spending.

Still, there are "tentative indications that the contraction phase of this business cycle is drawing to a close," he said. "Arguably, our economy has not been weakening cumulatively in recent weeks."

Recent economic indicators have been "more mixed" lately, with inventories falling at an "extraordinary" pace, he said.

"With production running well below sales, the potential positive effect of the inevitable cessation of inventory liquidation on income and spending could be significant," Green- span said.

Also, industrial commodity prices have been stable in recent weeks, and semiconductor prices have strengthened, he said. Low mortgage rates and good weather have spurred home sales. And automobile sales, though down from October and November incentive-induced highs, "have remained surprisingly resilient," he said.

"But that impetus to activity will be short-lived unless the demand for goods and services itself starts to rise," Greenspan said.

A number of factors are working against a pickup in demand, he said.

Mortgage rates have been rising in recent weeks, and that "is likely to damp housing activity and equity extraction," he said. The pace of home refinancing has "dropped noticeably" as rates have risen.

While declining oil and gas prices have "clearly provided support" for consumer spending, they will provide "only a one-shot boost to consumption, albeit one that is likely to take place over time," he said.

Futures contracts suggest energy prices are likely to stabilize or rise, mitigating the effect of the earlier price drops on spending.

The "steep decline" in stock prices since March 2000 has also curbed household spending, Greenspan said.

"Although stock prices have retraced a portion of their losses, the restraining effects to the net decline in equity values presumably have not, as yet, fully played out," he said.

Businesses have little ability to pass on costs, while productivity - though still high - has fallen. "The result has been that profit margins are still under pressure," Greenspan said.

Most important to the economic outlook is the likelihood that unemployment, currently at a 6 1/2 -year high of 5.8 percent, will continue to rise. "Job losses can be expected to put something of a damper on consumer spending," Greenspan said.

The Fed's 11 reductions in the benchmark overnight bank lending rate last year, to 1.75 percent, have helped boost demand, as has the phase-in of tax cuts enacted in 2001.

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