“Federal Reserve Chairman Alan Greenspan said that companies are slowly regaining the ability to raise prices and that the risk of deflation has disappeared,” writes Grep Ip in today’s Wall Street Journal.

“Nonetheless, he told a Congressional committee yesterday that ‘inflationary pressures will be reasonably well-contained so long as productivity is moving at a reasonably good clip’ and labor costs continue to decline.”

“Investors saw Mr. Greenspan’s remarks as more upbeat on the economy and slightly less sanguine on inflation than they had expected. In response, they concluded that an interest-rate increase by the Fed later this year appears more likely and so sold stocks and bonds. The yield on 10-year Treasury notes, for instance, surged to a five-month high of 4.47%.”

” ‘Pricing power is gradually being restored and threats of deflation, which were a significant concern last year, by all indications, are no longer an issue before us,’ the Fed chief said.

“Mr. Greenspan’s brief remarks on the economy, during testimony on banking at the Senate Banking Committee, didn’t appear to reflect any urgency to raise rates. Fed officials next meet on May 4, but they aren’t expected to lift rates then. Their current target for the federal-funds rate, charged on overnight loans between banks, is now at a 46-year low of 1%. Mr. Greenspan is to say more about the economy at a meeting of the Joint Economic Committee of Congress today.”

“While markets have seen big increases in commodity prices as harbingers of inflation, Mr. Greenspan, like other Fed officials, noted that they are a relatively small part of firms’ costs. Labor, by contrast, makes up two-thirds of companies’ costs. And he noted that labor costs per unit of output are declining, albeit at a slower rate than last year, thanks to continued brisk improvement in productivity, or output per hour.”

” ‘The productivity patterns that we’ve observed in recent months are still quite impressive, and still not fully understood by us,’ ” he said. That suggests the Fed’s decision on when and how quickly to raise rates will hinge to a great extent on how much productivity growth slows.”

The Fed chairman also said that despite some deterioration in loan quality during the 2001 recession, banks now “remain strong.” Some investors and analysts have worried that bank profits will be squeezed as interest rates rise, either because banks will have to raise rates on deposits faster than they can raise rates on loans, or because rising interest rates will hurt the market value of their bonds and mortgage-backed securities. But Mr. Greenspan said the bank industry is ‘adequately managing its interest-rate exposure.’ “