Inflation was hot in July, but rent isn't showing up yet and could drive prices higher
- The core consumer price index, which excludes food and energy, increased by 0.3% last month, slightly less than expected and well below the average 0.8% pace of the past three months.
- Economists said inflation’s hot streak seems to be moderating somewhat as price spikes driven by pent-up demand or shortages appear to be ebbing.
- Economists say rent is one area that is not yet showing strong gains, but it could become one of the more persistent factors in higher consumer prices.
Sharp post-pandemic price increases in some parts of the economy appear to be fading, but rent is one area in which inflation is expected to stick around.
The consumer price index rose 0.5% in July, well below the 0.9% pace in June. Core consumer prices, excluding food and energy, rose 0.3% last month, shy of economists' expectations for a 0.4% gain. Year-over-year, the CPI rose 5.4% year-over-year in July, the same as June.
Economists say there are signs the spike in inflation is temporary, as Federal Reserve officials have contended. But one big part of consumers' out-of-pocket expenditures is rent, and that is expected to rise well into the future.
Private sector reports show double-digit increases in rents across the U.S. this year, but the consumer price index actually showed a slight moderation in rental price gains in July. Economists say that should change as the Bureau of Labor Statistics data catches up, and the increases should be enough to keep the debate going about whether rising inflation is temporary.
"The composition was mixed, but generally softer than expected, as housing inflation slowed (owners' equivalent rent +0.29%, rent +0.16%) in stark contrast to the surging rents in the industry data," wrote Goldman Sachs chief economist Jan Hatzius.
"Additionally, the volatile hotel category contributed 0.08pp to the core," he added. "Both hotel and airfare price levels have returned to roughly their pre-pandemic trends, meaning that most of the inflation boost from rebounding travel services prices is now behind us."
The stickiness of higher rent costs
Rent and owners' equivalent rent cover housing costs and are about a third of CPI. Inflation in rent is stickier and more persistent than other price pressures. In the CPI, rent rose slightly slower in July than in June.
"The rent component is dramatically understated relative to reality, which means in the next couple of months, rent is going to catch up," Bleakley Global Advisors chief investment officer Peter Boockvar said. "Rental increases, which is the biggest chunk is only going to accelerate here. I don't see rent increases as transitory."
Boockvar said the Apartment List National Rent Report showed a rise of 2.5% in rental prices from June to July, and an 11.4% increase for 2021 so far.
Housing has been one of the hottest areas of the economy, as low interest rates fueled a surge in residential activity and consumers moved out of cities and to different regions due to the pandemic.
"A lot of the slowing we're seeing [in CPI] this month reflects used cars and a lot of the effects of Covid," NatWest Markets chief U.S. economist Kevin Cummins said. "The rent story is we're going to see them rising over the rest of the year, but the modest slowing in today's CPI could be just a blip."
"There's a lot of private sector data on rents," he said. "Those all have been a lot stronger and admittedly they were a lot weaker last year, so they probably exaggerate the rent strength but they do indicate rents are picking up."
Rent's impact on inflation over the long term
Economists say rent costs could be a factor that keeps the pace of consumer inflation running slightly higher than the Fed's target of 2%, once the effects of the economic reopening and supply chain shortages work through the system.
"I take a lot of solace in that [CPI] suggests strongly that the spike in inflation is temporary, that it is due to disruption created by the pandemic, and as we iron out those disruptions, inflation will moderate and go back close to the Fed's target," Moody's Analytics chief economist Mark Zandi said. "It's going to take some time, probably to this time next year, where we're back to 2% again. But that's where we're headed."
But while inflation often fell short of the Fed's target before the pandemic, it could run slightly higher due to rent inflation. "Instead of being 1.7%, 1.8%, it's going to be 2.1%, 2.2% and is going to be all boiled down to rent inflation and that's going to persist until supply kicks in and that's going to be a number of years," Zandi said.
He pointed to data from Yardi Matrix — an analytics company that studies commercial real estate — which shows the multifamily rental industry had a record-setting month in July, with rents rising 8.3% year over year and single family rentals up 12.8%. He said because of the Bureau of Labor Statistics' methodology, the rent increases will show up in CPI later.
The pressure on rental prices has to do with a long-running shortage of housing stock, which has roots going back to the financial crisis, Zandi said. As a result of the pandemic, people have also relocated from cities, and the areas where housing is tightest are in the South and Southwest.
"We need 1.8 million units per annum, and we're still at 1.6, 1.7 million. We're getting closer but we're still falling short," he said. "Vacancy rates across the housing stock are at 35-year lows and falling fast.
Cummins said higher rental costs are among the differences between his year-end 2022 core CPI inflation target of 2.4%, and the Fed's target. While the central bank watches personal consumption expenditures inflation data, it expects just 2.1% in that core measure by the end of next year.
"The labor market right now is pretty strong… If the labor market is presumably strong, you should see rents pick up," Cummins said.
Cummins also said it appears core CPI is moderating.
In July, new vehicle prices were up 1.7% in July after a 2% gain in June. Airline fares declined by 0.1% in July, but they are up 19% year over year. The index for lodging away from home continued to rise, increasing 6% in July after a 7% increase in June.
Food continued to gain, up 0.7%, and food away from home rose 0.8%. Energy costs also kept rising. Gasoline was up 2.4% and is up nearly 42% year over year.
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