An “open house” flag is displayed in front of a family’s home on September 22, 2022 in Los Angeles, California.
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There are signs that inflation may fall further in the coming months, but housing threatens to mute any improvement.
The consumer price index, the main barometer of inflation, increased by 7.7% in October compared to a year ago. While still quite high by historical standards, this annual reading was the smallest since January.
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The month-on-month increase was also less than expected – giving hope that stubbornly high inflation and its negative impact on consumers’ wallets may be easing.
However, shelter prices rose 0.8% in October – the biggest monthly gain in 32 years. At a time when many observers say the US is in a “housing recession,” this may seem counterintuitive.
Economists say shelter inflation — at least as reflected in the CPI, given its importance to household budgets and the internal dynamics of the rental and housing markets — will remain high for several months to a year.
“As the housing market cools, this category will ease, but we’ll have to wait until next year for that to significantly reduce headline inflation,” said Jeffrey Roach, chief economist at LPL Financial.
Housing is the largest household expense
The U.S. Bureau of Labor Statistics, which publishes the CPI report, breaks down the “shelter” category into four components: rent, out-of-home accommodation (such as hotels), renters’ and homeowner’s insurance, and landlord-equivalent rent.
Leaseholds and “owners’ equivalent rent” are the most important.
The latter tries to put landlords on an equal footing with tenants. That essentially reflects what homeowners would pay to rent their homes, said Cristian deRitis, deputy chief economist at Moody’s Analytics.
Housing is the largest expense for the average consumer. The overall CPI weighting reflects this: Shelter makes up 33% of it, the most of any category. Therefore, shelter has a large impact on overall month-to-month inflation.
Over the past year, the shelter category has grown by 6.9%.
Rental and housing markets are cooling
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Marking demand has caused home and rental prices to cool or moderate in many parts of the US
New home listings in the U.S. through Nov. 6 fell 17.5% year-over-year, according to real estate brokerage Redfin. The typical sale price, $359,000, is down more than 8% from a June peak of $392,000, according to Redfin.
Mortgage demand has eased as interest rates have steadily climbed to a recent peak of more than 7%, although rates fell sharply last week.
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Meanwhile, rent inflation slowed in 2022 from last year’s pace, according to Zillow data.
Americans paid an average market rent of $2,040 as of Oct. 31, according to the seasonally adjusted Zillow Observed Rent Index.
On September 30, the rental price increased by 0.31% compared to a month ago. However, the pace of this growth has slowed down for four consecutive months. By comparison, rents increased by about 1% per month from the end of May to the end of June. According to Zillow data, rent inflation reached 2% per month in July and August 2021.
Why shelter prices are lagging behind
According to deRitis, the CPI for “shelter” has historically lagged changes in home prices by four quarters, suggesting that shelters “will continue to put upward pressure on headline inflation through the first half of 2023.”
The lag effect is largely related to how long it takes for leases to transition to a new contract. Landlords typically renew leases every 12 months, meaning current price dynamics won’t be reflected in new contracts for a year.
In this sense, housing is slightly superior among other CPI categories. Consumers are not willing to pay the same price for chicken or eggs all year round, for example.
“The apartment has some unique aspects,” deRitis said.
According to economists, rents tend to be “sticky” — meaning that the total dollar amount of monthly rent generally does not decrease; tend to stay the same or increase with each new lease.