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Great Graphic:US Rents and Core Inflation

This post is extremely important for understanding the differences between CPI inflation in Europe and in the U.S. “Shelter” makes up 32.8% of the U.S. CPI basket, or 42% of the core inflation rate. It is mostly driven by “Owner’s equivalent rent of primary residence”. Shelter inflation in the U.S. is 3.2% per year (March 2016), but shelter inflation is only 1% in Europe.

 

CPI in the United States (source) in %
Shelter 32.776
   Rent of primary residence 5.930
  Lodging away from home 2.648
    Housing at school, excluding board (2) .154
    Other lodging away from home including hotels and motels (3) 2.493
   Owners’ equivalent rent of primary residence 23.830
   Tenants’ and household insurance .369

Moreover, rents make up 6.4% of the CPI basket in the euro zone and most importantly, the “owner’s equivalent rent of primary residence” does not exist in the European CPI basket. Both CPI baskets contain energy and other costs for housing, about 10% of the total.

This implies that rising inflation and costs for rents and owner-occupied housing push up the inflation differences between the U.S. and the euro zone.

It leads to the thinking that the Fed must raise rates, what again pushes up costs for owner-occupied housing, hence higher rates push up inflation.

In nearly all European countries rents are controlled by an indexing to interest rates. The landlord is only allowed to hike rents when he has higher costs, i.e. when he must pay higher interest rates.

Hence the key differences are:

  • Rents are 6% of the US CPI basket, 6.4% of the euro zone HICP basket.
  • Owner’s equivalent rent of primary residence are 23.8% of the US basket, but 0% (zero!) of the euro zone basket.
  • Rent-control measures in Europe, no or weak rent control in the U.S.
  • US Shelter inflation 3.2%, Euro zone rent inflation 1%
  • Asset-price inflation may lead into higher inflation (potentially hyper inflation) in the U.S., while regulation controls asset-price inflation in Europe.

 

Marc Chandler argues that asset price inflation does not lead to hyper inflation.

 

Median Asking Rent for Vacant for Rent Units: 1995-2016

That is a greater weight that core good or core services (excluding rent).  Rents account for 15% of the core PCE deflator, which the Fed targets, and helps explain the discrepancy between the two measures.

Median Asking Rent for Vacant for Rent Units: 1995-2016

Median Asking Rent for Vacant for Rent Units: 1995-2016

 

There are other measures of rent, including rent on primary residences.  However, what is important is the trend.

It is important because it is the key to US measures of core inflation.  Rent accounts for 42% of the core CPI basket. 
Many economists are musing over what has happened to the savings from the drop in oil prices.  Stewart’s post suggests that part of the windfall has gone to pay rent.   By the Census Bureau’s House Vacancy Survey, the asking rents have risen by 9% (~$71 a month) year-over-year in Q1 16.   Rent is commanding a greater share of household income.  The March CPI showed that shelter costs had risen 3.2% over the preceding 12-months.
In addition to shelter costs, another source of upward pressure on core measures of US inflation is medical services.  The price of medical services has increased 3.6% year-over-year.
This is not a Sirens’ call that monetary policy is fueling hyperinflation as many economists argued when the Fed first launched its asset purchase program.  Our point is that core measures of inflation are trending higher, and that shelter and medical services are important drivers.     Rising shelter costs may be reducing disposable income that the past drop in gasoline prices was lifting.
The issue in some circles is whether the FOMC will purposely tolerate inflation that exceeds target to show its symmetrical approach and/or to ensure that disinflation forces are defeated.   We are skeptical of the first argument.  Consider you are driving on the highway.  Fiddling with the radio, you drift a little into the lane to the left.  To demonstrate you that have a symmetrical approach, one does not drift purposely into the lane on the right.

 

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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