MNI INTERVIEW: Housing to Drive Up U.S. Inflation For Years

Surging home prices will put upward pressure on U.S. inflation for years to come as they trickle into rental and owners'-equivalent rent measures used in key consumer price indices, two economists from the Federal Reserve Bank of Dallas told MNI.

"Over the long haul, rents and housing prices do tend to move together, but there is a significant lag in movements in house prices finally translating into rents and feeding into our measures of inflation," said Jim Dolmas, Dallas Fed economic policy advisor and senior economist, in an interview.

Dolmas and Xiaoqing Zhou, also a senior economist, have modeled the lag between home price spikes and effects on rent and OER, determining it to be about a year and a half.

"There are various indices of listed rents for new units, you see those have already started to jump lately. But it takes a while for these things to make their way into the broader measures that go into the CPI, that go into the PCE," Dolmas said.

Their model sees rent inflation spiking to 3.0% by the end of next year from 1.9% in June -- and to as high as 6.9% by the end of 2023. They forecast that, together, rent and OER will add 0.6 percentage points to annual core PCE inflation for 2022 and about 1.2 percentage points for 2023.

The authors argue this "could push the overall and core PCE inflation rates above 2% in 2023, when current supply bottlenecks and labor shortages may have subsided."

Home prices grew at a record pace for a third month in June, as demand is propped up by shifting consumer needs and rising investor interest.

Dallas Fed President Robert Kaplan has been a vocal proponent of curbing the Fed's purchases of mortgage-backed securities because of the red-hot housing conditions.

DOUBLE-WHAMMY

Zhou said two forces were working at once: the normal rebound from a pandemic period that saw widespread rent forgiveness programs, and the statistical trickle-down effect from rising home prices themselves.

"This is going to put additional pressure on rental inflation and OER inflation going forward. House price growth is expected to increase going forward but it will decline at some point in 2022," she said.

"The surge in house prices is currently due to supply side constraints. We have an extremely low inventory of homes on the market and on the new home side, builders are facing supply bottlenecks and rising costs," added Zhou. (See MNI: Supply Kinks Strain 'Transitory' Price Surge--Fed Economist)

Higher-than-expected inflation readings in recent months have taken Fed officials by surprise and forced them to revise up their price forecasts. Still, Fed Chair Jerome Powell and other have stuck to the argument that price pressures are largely transitory, in line with the Fed's 2% long-run target.

Fortunately for Fed policymakers, who place great weight on inflation expectations, rents and OER do not seem to affect inflation expectations that heavily.

"There's not a lot of evidence that there's a particular channel that feeds through from house prices or even rents to people's expectations about inflation," Dolmas said.

"It's things like energy, food, core goods -- those things seem to have material impact on expectations of households for future inflation. But rent and house prices don't seem to play that big a role."

LONG LIST

A long list of supply chain disruptions, which look like being slow to unwind, could make price pressures linger longer than expected, Dolmas said.

"While much of what we're seeing right now with headline CPI and headline PCE is going to dissipate, there's still going to be a component that's going to persist," he said.

"We try to take into account a whole range of indicators of supply disruptions but we've found that in terms of forecasting they're only useful for one or two months ahead."

CPI jumped 5.4% in the year to July while the Fed's preferred PCE measure rose 4.2%.