Greenspan jolts markets with wage inflation alert

US Federal Reserve chairman, Mr Alan Greenspan has jolted international stock markets with a blunt warning that the extraordinary US economic expansion could be imperilled by a surge in wage-driven inflation.

Minutes after Mr Greenspan's remarks before the US House of Representatives Budget Committee became known, the Dow Jones Industrial Average of blue-chip stocks plunged 53 points and was down nearly 100 points at midday. It closed last night down 83.25 points or 1.02 per cent at 8095.06. Other European markets also faced late sell-offs on equity markets, with government bonds also hit, sending yields - long-term interest rates - higher.

Higher European long-term bond yields accelerated upward pressure on German interest rates and a jittery mood in Europe's bourses is now likely to be the order of the day, according to European market dealers. German 10-year yields rose yesterday to 5.48 per cent from 5.4 per cent the previous day.

In Dublin similar yields rose to 5.870 per cent from 5.828 per cent the previous day.

And European markets will be hit further if a forecast in a German newspaper that the Bundes bank could push up rates proves correct. The overwhelming majority of the council favours such a move - perhaps by nudging up the key money market securities repurchase rate - according to the Handeslblatt newspaper. Meanwhile dealers in the US said the chairman's cautionary comments caught traders on the New York Stock Exchange off-guard, triggering a sharp sell-off amid fears that the good times could be coming to an end.

European markets also ended lower. In Dublin the news came late in the day but still led to a fall in stock prices. The ISEQ index ended down 3.35 points at 3,382.42, with Bank of Ireland the main loser closing down 12p at 890p.

Analysts said Mr Greenspan may also have been signalling - or at least reminding - the markets of his readiness to tighten credit by increasing interest rates when the Fed's policy-making open market committee convenes on November 12th.

Mr Greenspan, who hit the markets last December with a single sentence - warning of "irrational exuberance" in the markets - had been widely expected to limit his remarks yesterday to issues affecting the federal budget.

But instead he warned in essence that demand for workers in a booming economy could soon outpace labour supply, sparking a rise in employment costs - and eventually in prices.

While the overall economy faced "uncertainties" ahead, the future of Wall Street was likewise cause for concern, according to the Fed chairman.

"Aside from the question of whether stock prices will rise or fall," he said, "it clearly would be unrealistic to look for a continuation of stock market gains of anything like the magnitude of those recorded in the past couple of years."

He told the committee that market operators "seem to have priced in an optimistic outlook characterised by a significant reduction in risk and an increasingly benevolent inflation process." But Mr Greenspan made clear there was no guarantee that inflation, currently benign, would remain in check - largely because of trends on the labour market.

"The performance of the labour markets this year suggests that the economy has been on an unsustainable track," he said, notably as fears of job loss - which in the past have suppressed wage pressures - have been fading.

In addition, he said, of the more than two million net new jobs since 1994, half have come from an expansion in the population. The remaining new employees are those who had been reported as unemployed.

"The key point is that continuously digging ever deeper into the available working age population is not a sustainable trajectory for job creation," Greenspan said.

At some point, he explained, people who are not now looking for work would have to be lured to the job market. "Rewards sufficient to make jobs attractive, however, could conceivably also engender upward pressures on labour costs that would trigger renewed price pressures, undermining the expansion," he warned.

The US unemployment rate - currently 4.9 per cent - has been below 5 per cent for months, levels not seen in decades.