Rising housing costs may support inflation for a while

Rents and other shelter costs are emerging as a major driver of overall consumer inflation, keeping it high at a time when many other sources are beginning to ease.

Economists expect housing inflation to strengthen further before cooling in the coming months, but they are uncertain when the relief will appear. This creates another challenge for the Federal Reserve as it raises interest rates to reduce price pressures.

Headline annual inflation fell to 8.3% in August from 8.5% in July, according to the Labor Department’s Consumer Price Index. That reflected declines from the previous month in prices for items such as gasoline, plane tickets and used cars, and slower price increases in other categories, such as groceries.

Housing was an outlier. Not only are the costs of shelter rising, they are rising at an accelerating pace, accounting for a growing share of overall inflation—about 25% of August’s rate, up from about 20% in February.

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Shelter costs – which mainly include rents and a measure of home prices known as owners’ equivalent rent – rose 0.7% in August from the previous month, up from 0.5% in July. They rose 6.2% in August from a year earlier, up from 5.7% in July.

The price of housing “was always going to be a sustained boost to inflation this year,” said Omair Sharif, head of consulting firm Inflation Insights LLC. “It’s definitely gone up over the last three months and that’s offsetting declines in things like airfares and hotel rates.”

Fed officials have raised interest rates this year at the fastest rate in decades to combat inflation, which hit a 40-year high in June. They are widely expected to raise interest rates by 0.75 percentage points after their two-day policy meeting that ended on Wednesday. It would be the third consecutive increase of that size.

Rising housing costs also increase the odds that the Fed will raise interest rates by 0.75 percentage points again at its November policy meeting, economists at Barclays wrote in a report to clients.

Economists and firms tracking private data expect CPI housing inflation to eventually cool because the rent increases they see in new leases appear to be slowing. It should show up in CPI with a delay because of the way it’s structured, they say. Most of the time, most tenants pay the same price every month, while those who renew their lease or sign new ones are more likely to see. an increase. Private firms, such as Apartment List Inc., which track rental prices, only record the rent amounts in new leases.

Using this method, the average U.S. rent rose 10% in August from a year earlier, down from a recent peak of 18% in November 2021, according to data from Apartment List.

The rent component of the CPI, on the other hand, is estimated based on rents paid across the market, which includes rents raised months ago.

Home prices rose sharply during the pandemic, boosted by low mortgage rates, changes in home buying preferences, population trends and low inventories of homes for sale.

But public authorities do not take house prices directly into account when calculating inflation because they view a home purchase as a long-term investment rather than a consumer good.

Instead, the CPI uses rents to create its estimate of homeowners’ housing costs — called owners’ equivalent rent — which calculates the imputed rent, or what homeowners must pay each month to rent their own house.

Because rents rose sharply over the past year, these increases are now fed into CPI and other measures of inflation.

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The private estimates give hope that housing inflation in the CPI will slow at some point, said Igor Popov, chief economist at Apartment List.

“On the one hand, there is some confidence that the shelter component of the CPI will not completely run away from us,” he said. “On the other hand, there is growing concern that the shelter component is, in the meantime, really supporting inflation at a time when these numbers are under a microscope.”

Sharif said increases in shelter costs should begin to slow either in the fourth quarter of 2022 or the first quarter of 2023. Barclays economists say that will happen in the fall. Brett Ryan, senior economist at Deutsche Bank, estimates that the peak will not come until the second quarter of next year.

Economists at the Dallas Fed said in a paper published last month that they see a lag time of up to a year and a half between when market rents start to fall and when that fall shows up in the CPI.

Write to David Harrison at david.harrison@wsj.com

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