There’s a growing concern about inflation heating up in the U.S. And now Goldman Sachs’ economists say a major component will keep driving higher.
Shelter inflation is set “to rise about 0.25pp to 3.1% year-over-year by later this year, providing a further 0.1pp boost to the core CPI,” according to Goldman’s David Mericle.
Shelter inflation is derived from housing costs based on rent, not price of homes. It has a 40% weight in core CPI and 18% of the core personal consumption expenditure (PCE). The PCE is the preferred measure by the Fed.
Mericle expects that “in the near term, lagged home price appreciation and declining labour market slack are likely to put upward pressure on rents.” He does expect this to moderate later though as new supply relaxes low vacancy rate.
Why is this important?
Housing supply in America is tight, which has increasingly been blamed for holding back the housing recovery and providing less of a support to the economy. And it is factoring into a key Fed consideration: inflation.
Earlier this week we got the Fed’s latest monetary policy decision. One of the key things markets were watching for was language on inflation.
The consumer price inflation report out on Tuesday showed that the core inflation rate was accelerating, rising 2% in the recent month. The PCE index was up 1.6% year-over-year, while core PCE — the Fed’s favourite measure of inflation — was up 1.4%. This is up significantly from March.
Yet, in her press conference Fed chair Janet Yellen downplayed the recent data describing it as noisy.
“Fed officials would surely notice a further drift upward in the core CPI, which stands just below 2% year-on-year as of May,” writes Mericle. “But the effect of faster rent growth would be smaller in their preferred inflation measure, the PCE price index, where housing receives less weight.”
For now it seems like housing is still one of the areas adding pressure to inflation. Soon we’ll know if it is enough to help the Fed meet its inflation mandate.