Gimme Shelter or Inflation Gonna Fade Away
|The Outlook for Inflation Amid Slower Home Price Growth
Executive Summary
In an expansion characterized by weak inflation, housing costs have bucked the trend. With housing being most consumers’ largest expense and prices rising faster than all other major categories of outlays, shelter has underpinned inflation in recent years. Yet shelter costs have eased up in recent months and home price appreciation has slowed sharply over the past year. Is the housing portion of inflation on the cusp of rolling over, and about to take overall inflation down with it just as core inflation looks to finally be aligning with the Fed’s target?
In this note, we provide background on how the CPI and PCE deflator measure housing inflation, as well as what recent price developments in the purchase and rental markets mean for what has been a major support of inflation in recent years. While home price appreciation has slowed, the effect on overall inflation in the coming months should be small—only about 0.1 percentage point lower by our estimates. Inflation for owner-occupied housing is expected to edge lower, but inflation for rented housing should be little changed amid steady wage growth and a low vacancy rate. As a result, core inflation should remain close to levels consistent with the Fed’s target, as the moderation in shelter costs is not enough to derail inflation in a meaningful way.
Shelter from the Tariff Storm
Tariffs have sucked up much of the oxygen in the inflation sphere of late, and understandably so. More widespread use of tariffs underscores that the tide of globalization has reversed, and with it an important driver of the disinflationary environment of the past three decades. As we have highlighted in earlier work, there are signs of tariffs filtering into consumer prices.1 Thus far the impact has been fairly modest, but we expect tariffs to have a greater bearing on inflation in the coming months as a much wider array of consumer goods now faces import taxes. Core CPI is already running at the fastest pace of the expansion, up 2.4% over the past year (Figure 1). Before getting too carried away that inflation is about to finally take off, however, it is worth taking a look at housing costs. The categories of goods we consider most directly exposed to tariffs account for about 8% of the Consumer Price Index, but shelter accounts for a whopping 33%. Housing has been the largest source of inflation in recent years at a time the Fed has struggled to reach its target. Not only is shelter the largest component of the CPI, but costs have been growing faster than any other major category of prices over the past four years. As shown in Figure 2, shelter costs have been rising more than 3% a year since 2015, which is similar to the pace of prior expansions. In contrast, goods prices have been falling up until very recently, and inflation for services ex-shelter has been running more than a percentage point below its pre-recession average. Given the size of the shelter component along with its relatively strong price growth, housing has accounted for about 60% of inflation over the past year, and added more than a full percentage point to headline CPI inflation.
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