Government data released on Wednesday showed inflation eased slightly in April but remains at relatively high levels. The latest report is unlikely to improve the gloomy mood of much of the public towards an otherwise solid economy.
Although incomes have generally risen more than consumer prices, overall inflation remains stubbornly high. It fell a bit in April but rose 3.4% from a year ago, according to the Bureau of Labor Statistics.
And unexpectedly, housing is the biggest culprit.
The Federal Reserve's perfect policy of fighting inflation by raising interest rates has worked across large parts of the economy. Higher interest rates have helped slow consumer price growth for things like food, gasoline, clothing and cars. Today, the inflation rate for these products has returned to or even below the central bank's 2% target.
But the same Fed policies have crippled housing, a key segment of the economy, and sabotaged efforts to reduce overall inflation.
What the higher interest rates have done is freeze both homeowners and renters, discouraging both groups from moving. The effect was strong in California, where housing – what economists call the cost of “shelter” – was already very expensive.
And in a complicated chain of cause and effect, the fact that both homeowners and renters are staying put has kept inflation high.
“For two years we waited for shelter inflation to drop enough to have an effect on overall inflation. It's consistently disappointing,” said GU Krueger, a longtime housing economist in Los Angeles.
“Because of the high interest rates,” he said, “there is no way to buy houses out of rental situations. Everyone is stuck: homeowners with golden handcuffs, renters actually with unadorned handcuffs.”
For homeowners, inflation helps make their homes more valuable. But selling is not an option for many, because they do not want to give up their lower mortgage interest rate. Today, the average interest rate with a 30-year term is over 7%. Higher house prices also mean they could lose the profits they made replacing the house they sold.
For tenants, there is not even the appearance of a profit: they are frozen because rents have not fallen, even though many new rental properties have come onto the market. The average rent for apartments and houses combined was about $2,920 in Los Angeles last month, making it one of the least affordable regions in the country, according to Zillow.
Now that more tenants are forced to stay put, many rental properties are experiencing greater demand and lower vacancy rates. This ensured that prices remained under pressure, even as more supply became available. Builders and landlords also charge rents to recoup higher construction and maintenance costs.
Last month, consumer spending on shelter accounted for about 36% of the basket of goods and services that made up the government's consumer price index (CPI).
Fed policymakers follow a different measure of inflation, with housing not given as much weight in the calculation of headline inflation. But both tell the same story: housing inflation is much higher than most other consumer goods and services.
In April, consumer prices rose by a total of 0.3% from March, on a seasonally adjusted basis, to an annual inflation rate of 3.4%, compared to 3.5% the month before. While that's a dramatic drop from a 40-year high of 9.1% in June 2022, the improvement is being slowed by persistent inflation in the housing market.
Shelter prices in April also fell slightly over the month, but rose 5.5% from a year ago, compared with 2.2% for all other goods and services combined, according to Bureau data or Labor Statistics.
Earlier this year, economists expected a bigger decline in headline inflation would prompt the Fed to begin the first of a series of rate cuts this spring. But with prices for housing and some other services remaining high, many analysts aren't so sure.
“I just don't see a catalyst for any kind of rate cut at this point,” said Jack Ablin, chief investment officer at Cresset, an asset management and advisory firm. “If we're lucky, we might get one discount this year.”
The Fed's benchmark interest rate, which affects interest rates on homes, cars and credit cards, is at a 23-year high at about 5.3%. Higher interest rates have been especially hard on California's economy, given the importance of interest rate-sensitive sectors such as high-tech, entertainment and real estate.
One result is that job growth in the state is lagging; California's latest unemployment rate, 5.3% in March, is the highest in the country. The state's employment report for April will be released on Friday.
Experts were more optimistic about a faster decline in inflation after seeing signs of falling rents last year. But average rents have risen again in recent months, partly due to larger increases in rental properties.
US rents for all homes rose an average of 0.6% in April compared to March, and are now below $2,000 per month, according to Zillow. That's an increase of 31% since the start of the pandemic.
In expensive markets like California, steep home prices and high mortgage rates have made homeownership more elusive and soured people's mood about the economy, with much of the blame falling on President Biden. Surveys show that renters are among the least happy in the state and many are considering leaving the state.
Chris Salviati, housing economist at Apartment List, which tracks new rental activity, said rents have fallen significantly from double-digit levels, but not fast enough. “It's still going in the right direction, but it's a gradual decline. It's definitely frustrating for people.”
Why is housing inflation so persistent?
One factor is that most people sign one-year leases, which causes delays and takes time for changes in rental prices to become apparent. When home prices plummeted during the Great Recession, it took about 18 months for the shelter component in the CPI to moderate, says Chris Rupkey, chief economist at Fwdbonds, a financial research firm.
CPI figures on shelter also tend to underestimate what many consumers experience. The data shows that rents for primary residences in Los Angeles and Orange counties increased 4.4% in 2022, even as prices for all other goods and services combined rose 9.3% that year. Since then, the trend has reversed: inflation for rent and housing has grown much faster than for all other items.
Experts say the recent rise in rents may be partly due to apartment owners trying to recoup their higher costs as the broader inflationary environment has led them to pay more for maintenance, supplies and labor.
“Landlords are trying to catch up,” said Erica Groshen, an economist at Cornell University and former commissioner of the U.S. Bureau of Labor Statistics, which publishes the CPI reports.
Some experts say one possible answer to housing inflation is for the Fed to cut interest rates. While it may seem counterintuitive for policymakers to take such action while the economy and labor market are still strong, lowering interest rates could boost mobility and also make it easier for builders to start more projects and so on. to increase the supply.
But boosting demand for home purchases could also boost home prices, at least in the short term, raising the risk of even more housing bubbles emerging.
“For the Fed,” Rupkey said, “it's damned if you do, and damned if you don't.”
