A tale of two chimneys
|The Impact of Recent Rent and Home Price Trends on Inflation
In the wake of this spring’s COVID-related lockdowns, there have been notable crosscurrents in the underlying inflation data. Initial virus-induced price swings are beginning to subside, but more persistent changes in demand are starting to emerge in the inflation data. Some of these categories have the potential to affect the medium-term inflation outlook, and chief among them is housing.
Official inflation measures of housing costs have eased recently for both renter and owner-occupied housing. Market-based measures, however, point to two distinct price paths. Home prices are being boosted by demand for more living space and record-low mortgage rates. But the strength has occurred at the expense of the rental market, where tenants have been hit disproportionately hard by job and income losses. While the inventory of homes for sale is at a 20+ year low, apartment vacancies have climbed to a near-decade high. Landlords have had to adapt to decreased demand with concessions and delayed/reduced payments.
In this note, we discuss the divergence between the rental and owner-occupied housing markets, and what it means for overall inflation. Recent home price appreciation should translate to a delayed, albeit modest boost to the owners’ equivalent rent component of shelter inflation, which will offset the disinflationary headwinds from the rental market. Perhaps the largest downside risk to inflation at present is the inability of renters to make payments, once housing memorandums expire at the end of the year, rent inflation could be sent tumbling.
Shelter Inflation Has Rolled Over
As most households’ largest expense, shelter carries an enormous weight in inflation indices. Shelter accounts for about a third of the Consumer Price Index (CPI) and a whopping 42% of the core CPI. Housing costs are a smaller although still sizable 17% of the Fed’s preferred inflation benchmark, the PCE deflator. The housing component of the PCE deflator is derived from corresponding estimates in the CPI, which we focus on herein.
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