Since Ben Bernanke became chairman of the Federal Reserve a year ago, he’s been talking up the moderating influence that a slowing economy will bestow on general price trends. In that time the economy has in fact slowed, but the jury’s still out on whether the moderating forces will deliver salvation on the inflation front.
Today’s report on January consumer prices offers one more reason to reserve judgment. Yes, top-line inflation appears contained, but core inflation (which excludes energy and food prices) continues to inch higher, as our chart below shows.

Core CPI is now running at a 2.7% annual pace through last month. That’s up from 2.6% for 2006 and close to the peak of recent years (2.9%) set last September. The rising pace of core inflation is a problem because the Fed is widely reported to have a target of 1-2% for core. By that standard, the central bank is behind the monetary eight ball.

The Fed, in sum, has more work to do to bring core CPI down, or at least convince the market that core CPI is no longer rising. There’s reason to wonder how this task will play out. As we reported on Monday, the pace of growth is rising for M2 money supply. Coincidence? For the moment, we prefer to err on the side of caution and answer “no.”
“This is kind of a wake-up call,” Mickey Levy, chief economist at Bank of America Corp., said of the latest CPI report. Inflation, he told Bloomberg News today, “is sticky, so it’s still on the front burner of concerns for the Fed.”
The leading driver of January’s rise in core CPI was medical care. That’s all the more troubling given today’s news from the Wall Street Journal (subscription required) that reports that the government’s share of financing for the nation’s healthcare continues to take wing. “As pressure grows for the government to pick up more of the nation’s health-care tab, new data show its contribution is already at 45% and is expected to approach 50% within 10 years,” the article advised. Add in the other big-ticket liabilities weighing on the government’s shoulders (Social Security, war-related spending in Iraq), and the pressure looks set to increase on the Fed for keeping the monetary printing presses rolling.
So far, the bond market has been inclined to look the other way when factoring in such risks when putting a price on money. As of yesterday’s close, the 10-year Treasury yield was near the lows for the year at 4.68%. The stock market doesn’t look worried either: the S&P 500 yesterday closed at its highest level since 2000.
Fear, in short, has been banished from the stock and bond markets. The optimism may roll on for some time. Bull markets don’t vanish in the wake of one economic report. But there’s a risk that Mr. Market may one day ask the Fed to show more muscle.