(Bloomberg) – The low rate of inflation is making the Federal Reserve Board nervous, and part of the problem is the sluggish rate of increase in health care costs.
Consumers would normally think that controlling health care costs is a good thing.
But, from the perspective of Federal Reserve Chair Janet Yellen and colleagues who are thinking about raising interest rates, the health care cost slump is one of the factors suggesting that they should keep rates at record low levels.
Price increases, not counting volatile food and energy costs, decelerated to a 1.1 percent year-over year pace in February. from 2 percent two years earlier, with medical goods and health-care services accounting for almost a third of the slowdown, according to government personal consumption exemption (PCE) data analyzed by Bloomberg.
The cost of health-care services rose just 0.8 percent in February from a year earlier, compared with an average 2.6 percent pace in the previous 10 years.
Prices of medical goods such as prescription drugs rose 2.2 percent, down from the 10-year average of 2.7 percent.
Behind the slowdown in medical costs: cuts in Medicare reimbursements under last year's budget sequestration, and an influx of cheaper generic drugs as patents expired on brand-name prescription medications.
Downward pressure on health costs may ease this year, because fewer patents are expiring.
Still, that won't be enough to lift overall price increases to the Fed's 2 percent goal.
"It's going to be a slow grind for medical care this year overall," said Omair Sharif, an economist at RBS Securities Inc. in Stamford, Connecticut. Health-care inflation levels are "not going back to the pre-recession days."
The Fed, which conquered runaway inflation in the 1980s under Paul Volcker's chairmanship, is now trying under Yellen to head off what many economists believe to be another problem, persistent disinflation.
Yellen has said that policy makers believe that a lack of inflation could "pose risks to economic performance."
Low interest rates hurt retirement savers and insurance lines that create long-term claim payment obligations, such as long-term disability insurance and long-term care insurance.
But many economists say low inflation rates make it harder for borrowers to pay off debts and for businesses to boost profits.
Investors are showing doubts about whether the Fed will succeed in rekindling inflation and are moving money out of exchange-traded funds tracking U.S. inflation. Traders pulled $524.6 million in the five days ended April 7 from the iShares TIPS ETF, the largest fund tracking Treasury Inflation Protected Securities. That erased all of the inflation bets accumulated in March, when the fund saw inflows of $326.8 million.
February's 1.1 percent core PCE reading matched January's as the lowest since March 2011. Including volatile food and energy costs, PCE inflation, the Fed's preferred gauge, was even weaker, slowing to a 0.9 percent year-over-year pace, less than half the Fed's 2 percent goal.
"If inflation is persistently running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer," Yellen said at a March 19 press conference.
The Fed's target for the federal funds rate has been at zero to 0.25 percent since December 2008
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Health-care costs, which make up almost a quarter of the core PCE gauge, will stay on a slow course this year, according to Bloomberg survey of 24 economists conducted April 1-3. That'll make it even tougher for inflation figures to justify tightening monetary policy.
Sixty-three percent of the economists surveyed see health inflation rising in 2014 at a pace that's short of historical averages, with an additional 8 percent projecting health-care costs will fall.
