“Sticky” shelter costs could keep overall prices uncomfortably high.
While inflation’s steady march downward of late has investors (and the Fed) cheering, it may be unwise to pop all of the champagne just yet.
The reason: Stubbornly high housing costs are keeping inflation in the services sector (as opposed to the goods sector) elevated. Broadly, the Consumer Price Index (CPI) rose by 3.6%* in December—but a closer look reveals that the cost of shelter jumped by a much larger 5.5%* (see the chart). That matters because the shelter category—a component of the services sector—accounts for a whopping 35% of the total calculated weight for the headline core inflation number.
In short, high housing costs could make it much tougher for overall inflation to fall back to the Fed’s target rate of 2%.
Housing costs remain high in part because of the sector’s natural lag time. Since rent prices are typically locked in for an extended period—12 months, for example—housing costs in aggregate haven’t kept pace with the lower prices we’re seeing for, say, eggs and gas.
That lag means shelter cost inflation may soon start to tick down along with many other segments of the economy. But that outcome isn’t assured. In fact, there are some concerning signs that shelter inflation could stay stuck around its current level—or maybe even rise. Some of the developments we’re monitoring in this area include:
- Mortgage rates have been falling lately, down from 8.09% in October to 6.92% recently following the general downward trend in longer-term interest rates. Lower rates that make homeownership more affordable could help fuel a surge in demand, putting upward pressure on housing prices that ultimately flow into the overall CPI inflation data.
- Housing prices have recently started to climb again after bottoming out in mid-2023, as elevated mortgage rates have kept the supply of existing houses for sale at low levels. The upcoming report on the median price of existing homes sold in December will be closely watched.
- High interest rate volatility over the past year or so has been a major driver of mortgage rates. If that volatility falls to more historically normal levels, mortgage rates could move significantly lower even if there’s no decline in overall interest rates. That, in turn, could further juice demand for homes—pushing up shelter inflation, services inflation, and overall inflation.
To be clear, inflation, in general, is experiencing a distinct downward trend at the moment. But as 2024 progresses, we’ll be watching developments in the housing sector for signs that this trend may be losing steam—and what that could mean for inflation and interest rates going forward.
* annualized monthly rate
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