Housing Costs Continue to Challenge Fed’s Inflation Control
Housing remains a persistent factor driving inflation, with the shelter component of the Consumer Price Index (CPI) continuing its upward trajectory. In September, this component increased by 0.6% over the previous month and surged by 7.1% on an annual basis. This substantial increase in the shelter component underscores the ongoing challenge that housing presents to the Federal Reserve’s efforts to manage inflation. Housing’s significant contribution to monthly inflation, accounting for more than half of the overall increase, highlights its impact on inflationary pressures.
According to EY Chief Economist Gregory Daco, the increase in the shelter index is expected to show more disinflationary momentum in the coming months. The Bureau of Labor Statistics reported a headline inflation rate of 3.7% for the 12 months through September, consistent with the August figure, and a 0.4% monthly increase. This persistent high inflation level aligns with the Federal Reserve’s commitment to maintaining a “higher for longer” approach to interest rates.
To achieve a reduction in inflation, a significant change in the shelter index, which constitutes one-third of the overall inflation index, is necessary. The shelter index comprises housing costs for both renters and homeowners, as well as costs associated with lodging away from home and tenants’ and household insurance. The two most critical elements of the shelter index are owner’s equivalent rent (OER) and rent, with OER representing 74% of the shelter index and rent accounting for 22%. In September, OER increased by 0.6% on a monthly basis, while rent prices increased by 0.5% on a seasonally adjusted basis.
Rent prices are a lagging indicator, which means they do not reflect real-time data accurately. The September rent component has yet to capture the significant deceleration in rent growth that began in the middle of the previous year. This month, rent prices increased only slightly by 0.1% compared to the same period last year, a noticeable decline from the 9% annual growth rate observed a year ago. Gregory Daco anticipates that the recent rent price increase is a temporary rebound and that prices will decrease in the latter part of the year.
While OER, which indirectly reflects home prices, remains relatively resilient, the momentum in home price disinflation has been less pronounced than initially estimated. Recent home price increases occurred before mortgage rates increased to nearly 8%, which had a cooling effect on buyers and coincided with the usual fall slowdown in market activity. The closed sales from August would have typically been contracted in July, when mortgage rates were significantly lower. As a result, home affordability reached a 38-year low in September due to rising rates and prices. Goldman Sachs housing economists project a 1.3% decline in home prices during the last five months of the year, which could help reduce shelter inflation and align with the Federal Reserve’s objectives. Daco anticipates that the shelter index will exhibit more disinflationary momentum in the coming months.
