NEW YORK (CNNfn) - Federal Reserve Chairman Alan Greenspan Thursday suggested Fed policy makers stand ready to raise interest rates again if they detect even the slightest sign that inflation is beginning to accelerate.
Greenspan, in a semiannual address to Congress, said no rate move is imminent, but warned the Fed will act to "promptly and forcefully" to respond to inflationary signals such as a drop in productivity or wage increases.
"The already shrunken pool of job seekers and considerable strength of aggregate demand suggest that the Federal Reserve will need to be especially alert to inflation risks," he said.
Greenspan's remarks roiled financial markets because many investors had expected the Fed to stand pat after raising its benchmark fed funds rate by a quarter of a point in June and shifting its stance to a neutral position from its previous tightening bias.
The 30-year Treasury bond tumbled almost a full point in price Thursday to 90-1/32, while the Dow industrials tumbled as much as 122 points before rebounding to close at 10,969, down 34 points.
Economists said Greenspan's remarks seemed to suggest another rate hike could occur later this year.
"We now think Greenspan will tighten before the end of the year by one quarter point," said Avery Sheldon, senior economist at CIBC World Markets. Previously, Sheldon expected the Fed to keep its benchmark short-term rate at 5.0 percent through 1999.
"Greenspan made clear the Fed had not done enough," said Sheldon who now expected the next rate hike to come in October or November.
Again a noncommittal Greenspan
Well aware of the impact his words have on Wall Street, Greenspan appeared to shun taking a hard tack for or against changing rates again.
As non-inflationary factors, he cited the likelihood consumption growth will slow because "outsized gains" in stock prices aren't likely to continue.
In the near term, Greenspan said, "there are mechanisms in place that should help to slow the growth of spending to a pace more consistent with that of potential output growth."
At the same time, Greenspan warned that any slowdown in the productivity gains that have driven the economy in recent years could cause inflation to rear its head.
"Should productivity fail to continue to accelerate and demand growth persist or strengthen, the economy could overheat," he said. "That would engender inflationary pressures and put the sustainability of this unprecedented period of remarkable growth in jeopardy."
However, he added, "The business and financial community does not as yet appear to sense a pending flattening in this process of increasing productivity growth."
Greenspan also warned that as international economies emerge from two years of turbulence, commodity prices -- which have been extremely low -- may turn up again and increase inflationary pressure on the U.S. economy.
That's because overseas consumers could start showing increasing demand for U.S. goods -- and forcing American companies to churn them out even more.
Explaining the move to a neutral stance at last month's meeting, Greenspan explained the FOMC "did not believe that its recent modest tightening would put the risks of inflation going forward completely into balance."
At the same time, however, he said the Federal Open Market Committee "did not want to foster the impression that it was committed in short order to tighten further."
The Fed expects the nation's gross domestic product -- the value of all goods and products made in the United States -- to grow between 3-1/2 and 3-3/4 percent this year, Greenspan said.
He also said inflation -- as measured by the Labor Department's consumer price index -- is expected not to pick up further after some increases early in the year, with the annual rate expected to be between 2-1/4 and 2-1/2 percent.
-- from staff reports with additional reporting from Reuters.