Rising Underlying Inflation Keeps Fed on Rate Hike Path

Consumer Prices
Lynne Sladky/AP

By Lucia Mutikani

WASHINGTON -- Rising shelter and medical care costs boosted underlying U.S. inflation pressures in April, a welcome sign for the Federal Reserve as it contemplates raising interest rates this year.

The Labor Department said Friday its Consumer Price Index, excluding food and energy, increased 0.3 percent last month. It was the largest rise in the so-called core CPI since January 2013 and followed a 0.2 percent gain in March.

Economists who had expected core inflation to increase 0.2 percent last month said the increase, which also reflected gains in the prices of household furnishings and new and used motor vehicles, should keep the U.S. central bank on track to hike rates before the end of 2015.

%VIRTUAL-pullquote-It will give the Fed greater confidence that inflation will indeed make it to its target in the next couple of years, it increases the odds of faster Fed action.%"It will give the Fed greater confidence that inflation will indeed make it to its target in the next couple of years, it increases the odds of faster Fed action," said Chris Rupkey, chief financial economist at MUFG Union Bank in New York.

In a speech in Providence, Rhode Island, Fed Chair Janet Yellen said she expected rates to rise this year, adding that the lift-off hinged on a firmer jobs market and signs that inflation was moving toward the Fed's target.

"I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium-term," Yellen said.

The dollar was trading higher against a basket of currencies on the inflation data and Yellen's comments. Prices for U.S. government bonds fell, while U.S. stocks were little changed.

Although slower economic growth in the first half of the year has diminished the chances of a mid-year rate hike, a tightening labor market and rising demand for housing suggest core inflation could continue to push higher this year even if medical costs subside.

Minutes of the Fed's April meeting released Wednesday said "many" policymakers didn't believe that the data by June "would provide sufficient confirmation that the conditions" for raising the key short-term interest rate had been meet.

A recent batch of weak data, including April industrial production and retail sales, has left many economists even doubting the Fed will raise rates in September.

The central bank has kept overnight interest rates near zero since December 2008. It tracks a price measure that is running below core CPI.

In the 12 months through April, core CPI advanced 1.8 percent after a similar gain in March.

"September is still the most likely lift-off date, but July is not out of the question, particularly not if we get another couple of robust rises in core consumer prices in May and June," said Paul Ashworth, chief economist at Capital Economics in Toronto.

Fading Dollar Rally

A fading dollar rally also was seen keeping core inflation on an upward trend. The dollar surged about 15 percent against the currencies of the United States' main trading partners between June last year and mid-March. It has handed back some of those gains and is now up only 10 percent.

"If sustained, that should help weakness in core goods prices continue to moderate," said Ted Wieseman, an economist at Morgan Stanley (MS) in New York.

The overall CPI edged up 0.1 percent last month after increasing 0.2 percent in March. It was held back by a 1.7 percent drop in gasoline prices and no change in food prices. Gasoline prices, however, have since risen.

In the 12 months through April, the CPI fell 0.2 percent, the largest decline since October 2009, after slipping 0.1 percent in March.

Core inflation was lifted by a 0.3 percent increase in shelter costs, which followed a similar gain in March. Shelter inflation is being driven by rising household formation, which is boosting demand for rental accommodation.

The medical care index rose 0.7 percent, the largest rise since January 2007. Household furnishings posted their largest gain since September 2008.

Prices for new and used cars and trucks rose for a third straight month. Airline fares, however, fell, as did apparel prices, which recorded their first drop since December.

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