Housing Costs, Inflation’s Biggest Component, Are Poised to Ease
From the WSJ
New rents are already softening, but that might not show up in official inflation data for months because of measurement delays.
The end is in sight for one of the biggest sources of inflation. Surging housing costs helped keep inflation high this year but have likely already swung into reverse, economists say.
The signal comes from private-sector indexes of rents on new leases, which tend to lead the consumer-price index measures by a little less than a year, said Alan Detmeister, economist at UBS.
“Last year we saw huge increases in these market rent measures in June, July and August, but they’re now coming in at or below their prepandemic pace,” he said. “That suggests we should now be past the peak for monthly CPI rent increases.” As a result, he predicted, inflation could be below the Federal Reserve’s 2% target by 2024.
The Fed is aware of the dynamics. Chairman Jerome Powell in a speech on Nov. 30 said, “As long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year. Indeed, a decline in this inflation underlies most forecasts of declining inflation.”
If shelter inflation does drag overall inflation closer to 2%, that doesn’t mean the inflation problem is over. Economists assume increases in rents and home prices will remain subdued, given the slowing economy and high mortgage rates. If instead they rebound, so, eventually, will shelter inflation. Furthermore, more persistent inflation pressures outside shelter might be at work beneath the surface.
“The idea that shelter in and of itself is the driver of inflation is a little overstated,” said Steven Blitz, chief U.S. economist at TS Lombard. Wages will continue to put pressure on other service prices as the labor market remains tight, he said.
Annual wage growth rose to 5.1% in November from 4.9% in October, the Labor Department reported Friday. That is one factor likely to lead the Fed to keep raising interest rates into next year.
Surging prices for autos, furniture and other goods drove the initial wave of inflation that began last year, as strong consumer spending—fueled by low interest rates, government stimulus and a reopening economy—collided with snarled supply chains. Russia’s invasion of Ukraine this year further whipped up prices for food, energy and other commodities.
Those forces have ebbed in recent months. Meanwhile, though, housing costs have risen. Shelter inflation accelerated from an annual pace of 3.5% in October 2021 to 6.9% a year later. In the six months ended October, it hit an annualized rate of 8.2%, the fastest since 1982.
Housing is influential because it is the largest component of the CPI: Tenants’ rent made up 7.4% of the CPI in September, and owners’ equivalent rent (OER), which measures homeowners’ costs, made up 24%. Shelter’s share of the core CPI, which strips out volatile energy and food prices, was an even larger 41.7%. As core inflation rose from 4.6% in October 2021 to 6.3% in October 2022, shelter inflation contributed around 1.4 points of the acceleration.
Shelter inflation tends to be “sticky,” meaning that once moving in any direction, it is slow to change. This has much to do with how it is calculated by the Labor Department’s Bureau of Labor Statistics. OER isn’t based on home prices or mortgage payments because home purchases are an investment, not just a commodity. Instead, the Bureau of Labor Statistics bases OER on what an owner would have to pay to rent her own home, drawn from rents in high-homeownership areas.
Meanwhile, most tenants’ rents change just once a year, and therefore don’t respond immediately when rents on new units increase. To capture what the typical tenant experiences, the CPI measure of tenant rent includes new and existing leases, and thus will tend to lag behind measures of new leases only.
“Because they’re looking at the overall pool of rents, and not just new rents, it’s like an oil tanker turning—it just takes time for market dynamics to feed through,” said James Knightley, chief international economist at ING.
The way the Bureau of Labor Statistics calculates the shelter index contributes to the lag, because it surveys each cohort of properties at six-month intervals, then calculates the price change using a six-month moving average. A jump in rent, therefore, takes nearly a year to show up, said Jake Oubina, senior economist at Piper Sandler.
Private-sector measures of mostly rents in new leases fell in the months after the pandemic hit, as many renters moved in with family and landlords were less likely to raise rent. The Zillow Observed Rent Index plunged at an annual rate of 5% from March to June of 2020, while the CPI shelter component rose 1.2% on the same basis. Then falling unemployment, federal income support and the reopening of the economy spurred demand for rental units and homes. Higher house prices made it harder for tenants to buy, enabling landlords to raise rents, Mr. Detmeister said. In September 2021, Zillow’s rent index peaked at a three-month annualized rate of 25.5%, while CPI shelter rose 4.2%.
Now, with stimulus exhausted, inflation eroding purchasing power and working from home on the wane, rent increases are decelerating. Zillow’s measure rose just 0.3% in October from September, 3.7% annualized, slightly less than the monthly average in the three years before the pandemic. CPI shelter rose 0.8% the same month, or 9.4% annualized.
If the CPI only measured market rents, core inflation would already be close to 2%, said Mr. Oubina. Given the lags, the drop in market rents “portends a significant deceleration in CPI rent measures,” he said. The Fed’s 2% target is based on the Commerce Department’s price index of personal-consumption expenditures (PCE), which assigns half the weight to shelter that the CPI does. Nonetheless, Mr. Oubina predicted the slowing in rents to date is enough to reduce core PCE inflation to 2% by the second half of next year.
New rents are already softening, but that might not show up in official inflation data for months because of measurement delays.
The end is in sight for one of the biggest sources of inflation. Surging housing costs helped keep inflation high this year but have likely already swung into reverse, economists say.
The signal comes from private-sector indexes of rents on new leases, which tend to lead the consumer-price index measures by a little less than a year, said Alan Detmeister, economist at UBS.
“Last year we saw huge increases in these market rent measures in June, July and August, but they’re now coming in at or below their prepandemic pace,” he said. “That suggests we should now be past the peak for monthly CPI rent increases.” As a result, he predicted, inflation could be below the Federal Reserve’s 2% target by 2024.
The Fed is aware of the dynamics. Chairman Jerome Powell in a speech on Nov. 30 said, “As long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year. Indeed, a decline in this inflation underlies most forecasts of declining inflation.”
If shelter inflation does drag overall inflation closer to 2%, that doesn’t mean the inflation problem is over. Economists assume increases in rents and home prices will remain subdued, given the slowing economy and high mortgage rates. If instead they rebound, so, eventually, will shelter inflation. Furthermore, more persistent inflation pressures outside shelter might be at work beneath the surface.
“The idea that shelter in and of itself is the driver of inflation is a little overstated,” said Steven Blitz, chief U.S. economist at TS Lombard. Wages will continue to put pressure on other service prices as the labor market remains tight, he said.
Annual wage growth rose to 5.1% in November from 4.9% in October, the Labor Department reported Friday. That is one factor likely to lead the Fed to keep raising interest rates into next year.
Surging prices for autos, furniture and other goods drove the initial wave of inflation that began last year, as strong consumer spending—fueled by low interest rates, government stimulus and a reopening economy—collided with snarled supply chains. Russia’s invasion of Ukraine this year further whipped up prices for food, energy and other commodities.
Those forces have ebbed in recent months. Meanwhile, though, housing costs have risen. Shelter inflation accelerated from an annual pace of 3.5% in October 2021 to 6.9% a year later. In the six months ended October, it hit an annualized rate of 8.2%, the fastest since 1982.
Housing is influential because it is the largest component of the CPI: Tenants’ rent made up 7.4% of the CPI in September, and owners’ equivalent rent (OER), which measures homeowners’ costs, made up 24%. Shelter’s share of the core CPI, which strips out volatile energy and food prices, was an even larger 41.7%. As core inflation rose from 4.6% in October 2021 to 6.3% in October 2022, shelter inflation contributed around 1.4 points of the acceleration.
Shelter inflation tends to be “sticky,” meaning that once moving in any direction, it is slow to change. This has much to do with how it is calculated by the Labor Department’s Bureau of Labor Statistics. OER isn’t based on home prices or mortgage payments because home purchases are an investment, not just a commodity. Instead, the Bureau of Labor Statistics bases OER on what an owner would have to pay to rent her own home, drawn from rents in high-homeownership areas.
Meanwhile, most tenants’ rents change just once a year, and therefore don’t respond immediately when rents on new units increase. To capture what the typical tenant experiences, the CPI measure of tenant rent includes new and existing leases, and thus will tend to lag behind measures of new leases only.
“Because they’re looking at the overall pool of rents, and not just new rents, it’s like an oil tanker turning—it just takes time for market dynamics to feed through,” said James Knightley, chief international economist at ING.
The way the Bureau of Labor Statistics calculates the shelter index contributes to the lag, because it surveys each cohort of properties at six-month intervals, then calculates the price change using a six-month moving average. A jump in rent, therefore, takes nearly a year to show up, said Jake Oubina, senior economist at Piper Sandler.
Private-sector measures of mostly rents in new leases fell in the months after the pandemic hit, as many renters moved in with family and landlords were less likely to raise rent. The Zillow Observed Rent Index plunged at an annual rate of 5% from March to June of 2020, while the CPI shelter component rose 1.2% on the same basis. Then falling unemployment, federal income support and the reopening of the economy spurred demand for rental units and homes. Higher house prices made it harder for tenants to buy, enabling landlords to raise rents, Mr. Detmeister said. In September 2021, Zillow’s rent index peaked at a three-month annualized rate of 25.5%, while CPI shelter rose 4.2%.
Now, with stimulus exhausted, inflation eroding purchasing power and working from home on the wane, rent increases are decelerating. Zillow’s measure rose just 0.3% in October from September, 3.7% annualized, slightly less than the monthly average in the three years before the pandemic. CPI shelter rose 0.8% the same month, or 9.4% annualized.
If the CPI only measured market rents, core inflation would already be close to 2%, said Mr. Oubina. Given the lags, the drop in market rents “portends a significant deceleration in CPI rent measures,” he said. The Fed’s 2% target is based on the Commerce Department’s price index of personal-consumption expenditures (PCE), which assigns half the weight to shelter that the CPI does. Nonetheless, Mr. Oubina predicted the slowing in rents to date is enough to reduce core PCE inflation to 2% by the second half of next year.
