Firming U.S. inflation keeps Fed rate hike on the table

[February 20, 2016]  By Lucia Mutikani
 
 WASHINGTON (Reuters) - Rising rents and healthcare costs lifted underlying U.S. consumer price inflation in January by the most in nearly 4-1/2 years, providing support for the view that the Federal Reserve could gradually raise interest rates this year as forecast.

The Labor Department said on Friday its Consumer Price Index, excluding the volatile food and energy components, increased 0.3 percent last month, the biggest gain since August 2011, following a 0.2 percent rise in December.

"This was a firm, broad-based rise in core inflation that should dispel the notion, evident in market-based measures of inflation compensation, that the economy can't generate any inflation," said Omair Sharif, rate sales strategist at SG Americas Securities in New York.

In the 12 months through January, the core CPI advanced 2.2 percent, the largest rise since June 2012 and exceeded the 1.9 percent average annualized increase over the last 10 years.

The core CPI was up 2.1 percent in December from the year earlier. The Fed has a 2.0 percent inflation target and monitors a price measure that is running well below the core CPI.

The overall CPI was unchanged in January after slipping 0.1 percent in December. The CPI increased 1.4 percent in the 12 months through January, the biggest rise since October 2014, after gaining 0.7 percent in December.

The year-over-year inflation rate is rising as the slump in world oil prices in the past year is washing out of the calculation.

POLICY MAKERS DREAM

Falling commodity and stock prices in the past few weeks, along with slowing domestic and global economic growth, had undermined market expectations for further Federal Reserve interest rate rises this year ahead of the central bank's next policy meeting on March 15-16.

The Fed lifted its benchmark overnight interest rate from near zero in December, the first rate hike in nearly a decade.

While Fed officials have worried about inflation being too low, they have also maintained that the factors holding back inflation are transitory.

But the rise in the core CPI in January, together with a tightening labor market, suggest further monetary policy tightening this year cannot be ruled out.

"It is a policymaker's dream come true, they wanted more inflation and they got it. The stronger inflation report puts a rate hike back on the table at the March meeting," said Chris Rupkey, chief economist at MUFG Union Bank in New York.

U.S. stock prices dipped on Friday, hurt by a drop in oil prices, and yields on shorter-dated U.S. Treasury debt rose, with investors digesting the inflation data that could raise prospects for further interest rate hikes this year. The U.S. dollar slipped against the euro and yen though.

CORE INFLATION BOOSTED BY RENT AND MEDICAL COSTS

Underlying inflation was last month boosted by a 0.3 percent increase in tenants' rent, which followed a similar gain in December. Medical care costs rose 0.5 percent, with prices for prescription drugs also increasing 0.5 percent.

The cost of doctor visits edged up 0.1 percent after falling 0.2 percent in December and hospital costs rose 0.4 percent.

Apparel prices shot up 0.6 percent, the largest gain in two years, after falling for four straight months. The increase in apparel is surprising as retailers have been offering deep discounts to sell unwanted inventory.

Prices for new motor vehicles advanced 0.3 percent. There were increases in the cost of tobacco and recreation, but prices of household furnishings dipped.

Though some economists were skeptical that the rise in core CPI would be sustained, revisions to the inflation data showed underlying inflation a bit firmer in the last months of 2015 than previously reported.

Following the strong core CPI reading, economists said they expected the Fed's preferred personal consumption expenditures (PCE) price index, excluding food and energy, to increase 0.2 percent in January after slipping 0.1 percent in December.

The core PCE was forecast rising 1.6 percent in the 12 months through January after increasing 1.4 percent in December. The Commerce Department will release the January PCE data next Friday.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci and Clive McKeef)

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