Here’s why it may take a while for housing inflation to cool

On September 22, 2022 in Los Angeles, California, an “open house” flag is displayed outside a single-family home.

Allison Dinner | Getty Images

There are signs that inflation may fall further in the coming months, but the housing market threatens to dampen any improvement.

The consumer price index, an important inflation barometer, rose 7.7% in October from a year ago. While still quite high by historical standards, that annual value was the smallest since January.

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The monthly increase was also smaller than expected, giving hope that stubbornly high inflation, and the negative impact it has had on consumers’ wallets, may be abating.

Still, the cost of shelter rose 0.8% in October – the biggest monthly gain in 32 years. That may seem counterintuitive at a time when many observers have said the US is in a “housing recession.”

But lodging inflation — as reflected in the CPI anyway — is likely to remain high for several months to a year, given its importance in household budgets and the intrinsic dynamics of rental and housing markets, economists say.

“As the housing market cools, this category will also ease, but we may have to wait until next year for it to dampen headline inflation in a meaningful way,” said Jeffrey Roach, LPL Financial’s chief economist.

Housing is the largest item of household expenditure

The U.S. Bureau of Labor Statistics, which publishes the CPI report, divides the “lodging” category into four components: rent, out-of-home lodging (e.g., hotels), renters’ and contents insurance, and owner-occupier equivalent rents.

Rent and “owner’s equivalent rent” are by far the most important.

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The latter seeks to put homeowners on an equal footing with renters. It essentially reflects what homeowners themselves would pay to rent their homes, said Cristian deRitis, deputy chief economist at Moody’s Analytics.

Housing is the largest part of the average consumer’s expenditure. The overall CPI weighting reflects that: Lodging accounts for 33% of it, the most of any category. Shelter therefore has an excessive impact on headline inflation from month to month.

The lodging category is up 6.9% over the past year.

The rental and housing market are cooling down

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Declining demand has caused home and rental prices to fall or moderate in many parts of the US

According to Redfin, a real estate brokerage, new home listings in the US fell 17.5% in the month through Nov. 6 compared to the same period a year earlier. The typical retail price, $359,000, was more than 8% lower than its peak of $392,000 in June, according to Redfin.

Demand for mortgages has fallen as interest rates rose steadily to a recent peak of over 7%, although interest rates fell sharply last week.

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Meanwhile, rental inflation has slowed in 2022 from the breakneck pace last year, data from Zillow suggests.

Americans paid an average market rent of $2,040 on Oct. 31, according to the Zillow Observed Rent Index, which is seasonally adjusted.

That rent was 0.31% higher than a month earlier, on 30 September. But the pace of that growth has slowed for four consecutive months. By comparison, rents were up about 1% from the end of May to the end of June. According to data from Zillow, rental inflation was 2% per month in July and August 2021.

Why accommodation prices are lagging behind

The CPI for “shelter” has historically lagged house price changes by four quarters, suggesting that shelter “will continue to exert upward pressure on headline inflation in the first half of 2023,” deRitis said.

The lag effect is largely due to how long it takes for leases to convert into a new contract. Landlords typically renew leases every 12 months, meaning current price dynamics aren’t reflected in new contracts for a year.

In this sense, housing is somewhat of an outlier between other CPI categories. For example, consumers will not agree to pay the same price for chicken or eggs for a year.

“Housing has some unique aspects,” deRitis said.

And according to economists, rent tends to be “sticky,” meaning that the total dollar amount of a person’s monthly rent generally doesn’t fall; it tends to stay the same or increase with each new lease.

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