Federal Reserve Board chairman Alan Greenspan said Tuesday the U.S. central bank is prepared to raise interest rates more quickly if inflation suddenly worsens.

Delivering his midyear economic outlook to the U.S. Congress, Greenspan said that economic conditions “have generally been quite favourable in 2004” with stronger growth finally producing some significant gains in employment. He noted that inflation has risen as well, but he repeated the belief that much of the increase in prices this year could be blamed on transitory factors such as a jump in oil prices.

As long as price pressures ease in coming months and don’t threaten to become embedded in wages, Greenspan said the Fed feels it can continue to raise interest rates “at a pace that is likely to be measured.”

But he cautioned that if inflation pressures do worsen, the Fed is prepared to act decisively to keep prices from getting out of control.

“The Federal Reserve will pay close attention to incoming data, especially on costs and prices,” Greenspan told the Senate Banking Committee.

The Fed raised interest rates for the first time in four years on June 30 by quarter-point, pushing its benchmark federal funds rate, the interest on overnight bank loans, from a 46-year low of 1% up to 1.25%.

In Canada, the Bank of Canada kept interest rates stable Tuesday but suggested that higher borrowing costs could be coming in the fall if inflationary pressures rise in the Canadian economy.

In the United States, most economists believe the Fed’s most recent rate increase will be followed by further quarter-point hikes at the Fed’s next meeting on Aug. 10 and following meetings this year and into 2005.

Bank of Montreal senior economist, Sal Guatieri, said, “Greenspan’s comments are consistent with our view that rates will increase in steady increments of 25 basis points at each of the next 13 policy meetings (the next one is on August 10). This pattern will slowly return the fed funds target rate, currently at 1.25%, to an estimated neutral level of 4.50% by early 2006.”

BMO noted that debt markets weakened and the US dollar firmed on Greenspan’s testimony, “as his upbeat comments on the economy seemed to cement expectations of a rate hike in August”.