Housing costs ‘dominant factor’ in Feb. inflation data as rents show signs of cooling [Video]

A cooldown in the housing market has started to spill into rents, even though the latest inflation data out Tuesday showed housing costs accounted for the majority of inflation pressures in the economy last month.

The shelter component of the February Consumer Price Index (CPI) — which makes up a third of the overall inflation index — rose 0.8% over the last month and 8.1% on a yearly basis in February.

The shelter index consists of rent prices and what it would cost the owner to rent an equivalent apartment, known as owners’ equivalent rent, which advances 0.7% over the last month.

The shelter index was the dominant factor in the monthly increase in the index for all items excluding food and energy, according to the Bureau of Labor Statistics report.

“Housing costs accounted for over 70% of the increase in February and [were] the largest contributor to the monthly growth rate,” Jeffrey Roach, chief economist at LPL Financial, wrote in a statement following the release. “This component will not likely be a significant driver of inflation by year end as more multifamily units come to market. “

This data from the BLS comes as real-time data from Redfin shows signs the rental market has started to cool off.

The median asking rent price for an apartment increased 1.7% from a year ago to $1,937 in February — the smallest gain since May 2021 amid higher vacancies and a big wave of new apartment supply, Redfin data out last week showed. February’s rent read marked the ninth-consecutive month that rent growth slowed from the prior year. Compared to January, rents in February fell 0.3%.

And this dynamic is expected to show up in the government’s data later this year.

“In the housing services sector, we expect inflation to continue moving up for a while but then to come down, assuming that [rent increases associated with] new leases continue to be lower,” Federal Reserve Chair Jerome Powell said in a press conference last month.

“Landlords are slowing their roll on rent increases because they’re grappling with a rise in vacancies as an influx of new apartments hits the market and demand slows from its peak,” said Redfin deputy chief economist Taylor Marr.

“Rents are likely to be close to hitting a floor, though. That’s because stubbornly high inflation is boosting expenses for landlords, so instead of dropping rents they may seek to lure renters with other concessions, like free parking or a discounted added security deposit,” Marr .

Data from the National Association of Home Builders showed the number of apartments under construction rose around 25% over the last year to 943,000 in January, the highest level since 1974.

Housing construction of 2-or-more units grew 35.1% by the end of 2022, and the fruits of this move will come to market over the next year as it takes about 15 months to complete a multi-family home, per research from realtors .com.

Apartments for rent are shown in Portland, Ore., Tuesday, Nov.  10, 2015. A wave of evictions and skyrocketing rents are putting apartments out of reach of many, including those working part-time, low wages or artistic jobs.  Some Portlanders are now looking for better-paying jobs and some are giving up and leaving.  (AP Photo/Don Ryan)

Apartments for rent are shown in Portland, Oregon.

Tighter labor market, higher rents

It’s no secret that the labor market remains resilient in the face of higher interest rates.

Friday’s February jobs print blew past expectations once again as the US economy added 311,000 jobs, a slower pace from the January’s gain but more than the 225,000 jobs that were expected.

And researchers at the Federal Reserve Bank of Kansas City warned in a paper published earlier this month rental inflation will stay above pre-pandemic levels as long as the labor market remains strong.

The study found rent inflation contributed about 3% to core CPI inflation — or roughly half of the total increase in consumer prices increasing excluding food and energy — in the fourth quarter of 2022.

As a result, even if inflation for goods eases, rent inflation would need to “meaningfully decline” to return to the Fed’s 2% inflation target.

“The outlook for rent inflation depends most importantly on labor market tightness,” wrote Kansas City Fed researchers Brent Bundick, A. Lee Smith, and Luca Van der Meer. The key sticking points driving demand for shelter are growth in employment and wages, researchers noted.

“Although the historically tight labor market has contributed to elevated rent inflation, other pandemic-related factors are also responsible for the increase,” the researchers noted.

Those factors impacting the pandemic-era surge in rents could be related to remote work and higher input costs for building and maintaining rental units, “both of which led to a boost in home prices that has further contributed to rent inflation.”

Higher rates tend to ease rent inflation

Fed Chair Powell made clear last Tuesday policy makers are prepared to respond to recent strong economic data by raising interest rates “higher than previously anticipated,” which could offer some relief to renters in the coming months.

In a study published in February, researchers from the Federal Reserve Bank of San Francisco found monetary policy tightening cools down the housing market and reducing rent inflation, though this tends to materialize slowly.

“A policy tightening equivalent to a 1 percentage point increase in the federal funds rate can reduce rent inflation — as measured by 12-month percentage changes in the personal consumption expenditures (PCE) housing price index — by about 3.2 percentage points over the course of 2½ years,” San Francisco Fed researchers Zheng Liu and Mollie Pepper wrote.

Since March of last year, the Fed has sharply increased its federal funds rate target range by a cumulative 4.5%.

“Although average rents are slow to respond to policy changes, the growth of asking rents on new leases has started to slow following recent monetary policy tightening,” wrote Liu and Pepper. “Our finding suggests that this tightening will gradually bring rent inflation down over time, thereby helping to reduce overall inflation.”

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv

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