The US economy is likely to strengthen following a first-quarter setback that was heavily influenced by fleeting factors such as bad weather, leaving the Federal Reserve primed for a first rate rise this year, Janet Yellen said on Friday.
The Fed chair said the US was “well-positioned” for continued growth — even if the expansion was likely to be moderate because of factors such as a slow improvement in the housing market, modest business investment and persistent weakness in the energy sector.
She argued that given the time-lag involved in setting monetary policy, the Fed could not afford to delay tightening until employment and inflation were back at its objectives, given the risk of the economy overheating.
Ms Yellen said: “If the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalising monetary policy.”
Subsequent rate rises were likely to be “gradual”, Ms Yellen added, given the headwinds that would continue to hold back growth. It would be “several years” before the federal funds rate was back to its normal, long-term level.
The Fed this year dropped its pledge to be “patient” before raising rates, shifting to a new footing where it can tighten policy as soon as it decides the economic outlook is strong enough to merit a rise. However, the US outlook has been clouded by weak first-quarter data, with gross domestic product growth of just 0.2 per cent reported for the period.
Ms Yellen said the recent data suggested the pace of improvement in the economy “may have slowed” and that there was still more slack in the labour market than low headline unemployment figures suggested.
However, the Fed chair said the apparent slowdown was “largely the result of a variety of transitory factors that occurred at the same time, including the unusually cold and snowy winter and the labour disputes at ports on the west coast — both of which likely disrupted some economic activity”.
In addition, some of the weakness might also simply be “statistical noise”, she said, adding: “I therefore expect the economic data to strengthen.”
Ms Yellen pointed to positive signs in the labour market, including an impressive rise in the number of job openings and anecdotal evidence of wage increases by big retailers such as Walmart and Target that could point to quicker wage gains.
Given recent savings on gas prices, on top of job gains, households’ real disposable income had risen almost 4 per cent nationally over the past four quarters, she added.
That did not mean the US was on course for blockbuster growth for the remainder of this year or beyond.
Housing sector activity was likely to improve only gradually, given the lasting impact of the downturn, while businesses were still proving reluctant to invest. Many had not had sufficient confidence in the “strength and durability of the recovery”. Weak energy sector investment was also likely to persist, she argued, even if the fall in the oil price was on balance a plus for consumers.
On the other hand, drags from fiscal retrenchment may largely be behind the US, while the euro area appeared to be on a firmer footing, she said.
Ms Yellen said most projections from the Federal Open Market Committee members were for growth of around 2.5 per cent for the next couple of years, with unemployment set to drop to 5 per cent by the end of the year. Inflation would move towards the Fed’s 2 per cent objective as the economy strengthened.
There were signs of firmer inflation on Friday as core consumer prices, which exclude food and energy, rose 0.3 per cent in April, the strongest monthly rise since early 2013, pushing the annual rate to 1.8 per cent.
One longer-term worry, however, is weak productivity data.
“I have mentioned the tepid pace of wage gains in recent years, and while I do take this as evidence of slack in the labour market, it also may be a reflection of relatively weak productivity growth,” said Ms Yellen.
It was therefore important for the nation to pursue measures to boost productivity.
“Policies to strengthen education, to encourage entrepreneurship and innovation, and to promote capital investment — both public and private — can all be of great benefit.”
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