The acceleration in U.S. core Consumer Price Index (CPI) inflation in March was in line with expectations, and likely a welcome development for Federal Reserve officials after a surprising string of soft inflation prints last year. The 0.3 percentage-point increase brought core CPI to 2.1% year-over-year as a large drop in wireless services prices last March finally fell out of the calculation, and we expect the pace to pick up further over the next few months (to 2.3%–2.4%) before settling back to 2.2% by year-end.
Digging into the details of the March print, we think two trends bear watching:
- First, the firming in medical services inflation we’ve been expecting has started to materialize, which should support inflation over the next year.
- Second, despite the recent U.S. dollar depreciation, core goods remain on the mild deflationary path we’ve seen for the better part of the last several years. However, we continue to forecast some firming in core goods prices this year despite firms’ more muted pass-through of rising input costs.
Policy changes support pickup in medical services inflation
We expect the pace of medical services inflation to rebound to around 3.0% in 2018 after moderating to 2.0% year-over-year in 2017. One supporting factor is a Trump administration policy change that increased outpatient Medicare reimbursement rates by 4.4% in January 2018. Although the CPI does not directly capture the prices of hospital services paid by government-administered health insurance programs, the higher Medicare payout rates will likely spill over into private insurance markets and boost CPI over the next several months. Indeed, hospital services inflation printed at 0.6% month-over-month in March, with help from a 0.7% increase in outpatient hospital services prices.
Furthermore, we see some other evidence of rising healthcare costs in the Bureau of Labor Services’ Employer Costs for Employee Compensation measure. While shifts in the underlying sample composition can make quarterly changes in this series noisy, the year-over-year rate of service sector health insurance costs – which has loosely led CPI healthcare inflation in the past – jumped at year-end 2017.
Core goods inflation slows, but PPI may be signaling an uptick
Meanwhile, core goods prices declined month-over-month in March (-0.13%) and remained in deflationary territory year-over-year despite U.S. dollar depreciation and evidence of rising pricing pressures in the Producer Price Index (PPI). It’s important to note, however, that the acceleration in industrial sector input costs – including the rising industrial metals and equipment costs reported in the PPI – is likely being absorbed by margin compression along the supply chain, since it has not yet begun to spill over discernably into the input costs of core consumer goods production. The latter tends to lead core consumer goods inflation by a few quarters, so while we continue to expect some modest firming in core goods, we will be monitoring these trends closely.
The acceleration in core inflation to 2.1% over the past several months is in line with our forecasts, and we expect the pace to pick up further to 2.3%–2.4% by midyear before settling back to 2.2% by year-end. We now view the risks around our forecasts as more balanced than we did last year, when risks appeared skewed to the downside. And from a bottom-up perspective, firming healthcare inflation should support the aggregate core inflation measure despite the more muted trends in core goods.
For more of PIMCO’s views on the complex drivers of inflation in the U.S. and globally, please visit our inflation page.
Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributor to the PIMCO Blog.