U.S. Federal Reserve chairman Alan Greenspan said Wednesday that the U.S. economy has made “impressive gains” since last summer and predicted that the lagging job market will perk up.

But he also drew attention to the deepening federal deficit as a risk factor, saying it must be addressed soon to avoid “serious longer-term fiscal difficulties.”

In delivering part of the Fed’s twice-a-year economic report to Congress, Greenspan repeated the central bank’s recent pledge to be patient in keeping interest rates at a 45-year low to ensure that the economic rebound takes hold.

However, he cautioned that low interest rates “will not be compatible indefinitely” with the Fed’s primary job of fighting inflation.

He said economic conditions have been helped by a reduction in geopolitical tensions, strengthened consumer and business confidence and a sharp rebound in economic growth as measured by gross domestic product.

Greenspan held out hope for an improving labour market in coming months as continued growth makes businesses more confident about hiring back laid-off workers.

“As managers become more confident in the durability of the expansion, firms will surely once again add to their payrolls,” Greenspan said.

Greenspan also noted a couple of things that could derail the U.S. economy’s prospects. Among the risks he listed were a sharp increase in oil and natural gas prices and the possibility that investors will become spooked by the soaring budget deficit.

Last week, the administration projected that this year’s deficit will hit an all-time high of US$521 billion.

“Should investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible,” said Greenspan.

Greenspan’s testimony was accompanied by a new Fed forecast for 2004 that was moderately more optimistic than the July forecast.

The new forecast predicts GDP will grow by between 4.5% and 5% in 2004, up from the July forecast of 3.75% to 4.75%.

The Fed expects the unemployment rate, which declined in January to 5.6%, will show a slight improvement, edging down to between 5.25% and 5.5% by the fourth quarter.

It also projects that prices will remain stable, with inflation of one to 1.25%.

Bank of Montreal says that in his testimony, Greenspan confirmed that, despite a very accommodative policy stance and a strengthening economy, the Fed can hold short-term rates low for a while longer. “In our view, this means the Fed will wait until August 2004 before gradually raising the fed funds rate from a current 1.0% to a more neutral level of 4.50% by early 2006.”

BMO Nesbitt Burns notes that both stocks and bonds rallied on Greenspan’s comments. “Bulls and bears will find something to cheer about in Mr. Greenspan’s well-crafted cagey comments. He was very optimistic about the future growth of the economy, yet he highlighted the need to remain alert to the risks, which include rising energy prices, the budget deficit and potential associated rise in long-term interest rates, and protectionism.”