US Federal Reserve Chairman Alan Greenspan removed a major obstacle to a rise in interest rates on Monday, declaring the end of a near year-long deflationary threat.
Banks were prepared for rising rates, he said.
"It is apparent that pricing power is gradually being restored," Greenspan told a Senate Banking panel.
"Threats of deflation, which were a significant concern last year, by all independent indications are no longer an issue before us," the powerful 78-year-old central bank chief said.
"Clearly, it is a change that has occurred in the last number of weeks and it is a change, as best I can see, that has been long overdue and most welcome," he said.
It was his first clear pronouncement of the death of the deflation risk, removing one of the biggest obstacles lying between the Federal Reserve and a rise in near rock-bottom interest rates.
Federal Reserve policymakers have cited the threat of deflation for 11 months.
The risk, though minimal, of a broad decline in consumer prices was judged to be so grave that it justified keeping key short-term interest rates at the lowest level since 1958 for the past 10 months.
But official figures showed core consumer prices rose 0.4 percent last month, the steepest increase in underlying inflation in three years.
The prospect of an economy-cooling rise in interest rates spooked investors, sending the Dow Jones industrial average tumbling 123.35 points, or 1.18 percent, to 10,314.50.
The dollar, which attracts buyers when returns are boosted by higher rates, strengthened. The euro dropped to US$1.1858 in the afternoon from US$1.2023 late Monday.
Greenspan was speaking amid feverish worldwide speculation that he may soon decide to lift the key federal funds rate, which banks charge each other, from 1 percent.
Some investors fear banks and major financial institutions would be hurt by such a move.
But Greenspan said the data showed that the banking industry was adequately managing its interest rate exposure.
"Many banks indicate that they now either are interest-rate neutral or are positioned to benefit from rising rates," he said.
Some economists say the Federal Reserve may raise rates as soon as June if consumer prices keep rising and if employers sustain a recent spurt in jobs creation.
Policymakers had cut the federal funds target rate 13 times since January 2001, when it stood at 6.5 percent, to counteract the Internet bubble, Sept. 11, 2001 attacks, corporate scandals and the US-led Afghan and Iraq wars.
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