U.S. inflation tame, but medical costs and rents pushing up

By Lucia Mutikani WASHINGTON (Reuters) - U.S. consumer prices barely rose in August, but rising rents and medical care costs pointed to some stability in underlying inflation that could make the Federal Reserve more comfortable trimming its bond purchases. The Labor Department report on Tuesday showed inflation largely under wraps, but some details suggested a down drift in prices earlier in the year had probably run its course. "This should give policymakers greater confidence that the inflation soft patch in the first half was indeed transitory," said Joseph LaVorgna, chief economist at Deutsche Bank Securities in New York. "As a result, some fence-sitting participants may feel marginally more comfortable proceeding with a mini-taper of quantitative easing." Fed officials were set to meet on Tuesday and Wednesday to deliberate on monetary policy. Most economists expect the U.S. central bank to announce a scaling back of the $85 billion in bonds it has been buying each month at the end of the meeting. The Labor Department said its Consumer Price Index edged up 0.1 percent last month as the cost of energy fell and food prices remained muted. The CPI had risen 0.2 percent in July. In the 12 months through August, it increased at a slow 1.5 percent pace after advancing 2.0 percent in the 12 months through July. Stripping out the volatile energy and food components, the so-called core CPI rose 0.1 percent after increasing by 0.2 percent in each of the past three months. Rents and medical care accounted for most of the increase in the core CPI. The latest gain took the increase in the core index over the past 12 months to 1.8 percent, the largest rise since March. The core CPI had gained 1.7 percent in July. Earlier in the year core inflation was moving lower, and reached levels that caused unease among some Fed officials. It touched a two-year low of 1.6 percent in June, but has been inching up for the last two months. LOW INFLATION TEMPORARY? The Fed targets 2 percent inflation, although it tracks a gauge that tends to run a bit below the CPI. Fed Chairman Ben Bernanke has viewed the low inflation as temporary and expects prices to push higher as the economy strengthens. The inflation data supported prices for long-dated U.S. government bond prices. The dollar was marginally lower against a basket of currencies, while U.S. stocks were trading higher. Interest rates have risen over the past few months in anticipation of the Fed's taper announcement. There is little sign, however, that high mortgage rates are putting a damper on home building. A separate report showed confidence among homebuilders unchanged near eight-year highs in September. Last month, inflation was held back by a 0.3 percent drop in energy as the cost of gasoline, electricity and natural gas fell. Energy prices had increased 0.2 percent in July. Food prices gained 0.1 percent, rising by the same margin for a second straight month. Away from food and energy, there were pockets of pricing power, with housing and medical care costs advancing. There were gains in rent, which accounts for about a third of the core CPI. Owners' equivalent rent of primary residence posted its largest gain since November 2008. Demand of rental housing has been rising as Americans shift away from owning a home. Rising mortgage rates could ensure that trend remains entrenched for a while. Medical care costs rose 0.6 percent, the largest increase since July 2007. Prescription drugs also recorded their biggest rise since July 2007. Medical care, which makes up more than 9 percent of the core, has been one of the key contributors to the low inflation early in the year. "What consumers are saving on gas they are paying for in medical care and rent," said Jay Morelock, an economist at FTN Financial in New York. "Even with consumer prices in check, however, the year-over-year increase in rents will support the case for tapering." On a year-on-year basis, rent of shelter posted its largest rise in five years. But some economists do not think core prices will continue pushing higher, arguing that the so-called cyclical components of inflation remained subdued. These are tied more closely to the economy's performance and include new and used motor vehicles, hotel room rates, airfare and apparel. All either declined or were nearly unchanged in August. "It is hard to imagine that rent will be rising at such a rapid clip in the coming months. Taking all that into account, the picture for the core rate suggests subdued readings ahead," said Omair Sharif, an economist at RBS in Stamford, Connecticut. (Reporting by Lucia Mutikani; Editing by Andrea Ricci)