US Federal Reserve Chairwoman Janet Yellen
US Federal Reserve chair Janet Yellen expects to raise interest rates later in 2015Reuters

The US Federal Reserve looks set to raise interest rates later this year after Janet Yellen said the economy was likely to strengthen - despite a first-quarter slowdown.

Speaking to a business group in Providence, Rhode Island, the Fed chair 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."

The US, she added, was "well-positioned" for continued growth because of "waning headwinds", despite only a slow improvement in the housing market, modest business investment and persistent weakness in the energy sector.

Yellen explained the first-quarter slowdown as being down to "statistical noise" and "transitory factors... 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".

Construction and productivity remain slack

In the speech, she noted: "Despite the recovery I noted in home prices and a greater number of home sales, residential construction activity remains quite low. I mentioned the ongoing issues with mortgage credit, but more generally, many years of a weak job market and slow wage gains seem to have induced many people to double-up on housing, and many young adults continue to live with their parents.

"Population growth is creating a need for more housing, whether to rent or to own, and I do expect that continuing job and wage gains will encourage more people to form new households. Nevertheless, activity in the housing sector is likely to improve only gradually.

"The pace of business investment has also been only modest during this recovery, and some of the reasons might persist a while longer. Businesses seem not to have had sufficient confidence in the strength and durability of the recovery to undertake substantial capital expenditures.

"Moreover, some analysts have suggested that uncertainty, not only about the strength of the recovery but also about economic policy, could be a significant factor. And the fact that many businesses seem to be holding large amounts of cash may suggest that risk aversion is playing a role."

Yellen, however, expressed concern over 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," she said.

"Policies to strengthen education, to encourage entrepreneurship and innovation, and to promote capital investment — both public and private — can all be of great benefit."