Inflation will continue to be boosted by one key component of consumer prices: rent.
That’s according to Bank of America Merrill Lynch economists Emanuella Enenajor and Michelle Meyer.
They wrote in a note Wednesday about owners’ equivalent rent, which is calculated based on rents tenants pay. It makes up a quarter of total CPI and is the largest category of rent, which takes up 32% of the consumer price basket, BAML noted.
Of course, rising rents would not be welcome news for renters, particularly if wages continue to rise slower than inflation. But they would be for the Federal Reserve, which is counting on more inflation to justify higher interest rates.
To be clear, the Fed relies on a different inflation gauge — personal consumption expenditures — which goes beyond prices consumers pay to include business spending. Still, CPI is a closely-watched and important measure.
We disagree with those who are calling for the end of the gains in rental inflation. Rather, our baseline forecast is for OER inflation to gradually edge higher: from 2.9% yoy in 2015 to 3.1% this year and 3.3% next year. In this environment, we expect rising rent pressure to keep overall CPI inflation supported, helping to maintain the wedge between the consumer price index (CPI) and personal consumption expenditure (PCE) inflation.
Housing costs are already a major driver of inflation.
Since mid-2012, shelter inflation has outpaced virtually everything else.
And right now, there are concerns that the pass through of rental costs to overall inflation may decline because of a slowdown in the high-end portion of the market.
But BAML doesn’t think that decline should drag down OER, since the top end of the market is only a small segment.
More importantly, the reality of a falling vacancy rate and rising demand will drive up rents everywhere else.
This imbalance of supply and demand, which we’re seeing across the housing market, would be sustained by a strengthening jobs market and household formation, BAML said.
And that’s good for inflation.