CPI Housing Costs Remain Elevated, Industry Data Disagrees, Here’s Why

January Consumer Price Index inflation came in at 6.4% annually for all items and 5.6% once food and energy are stripped out. That’s the smallest annual increase since 2021.

However, the month-on-month change in prices for January 2023 from December 2022 was 0.5% and may be a concern for the Fed. Inflation is coming down, but not as fast as the U.S. Federal Reserve would like and could linger at a rate above the Fed’s 2% goal for annual inflation.

The Housing Puzzle

One of the largest components of CPI report is housing costs, which the CPI terms “shelter”. These costs make up 34% of the inflation index. For January shelter costs, according to CPI data, rose 0.7% month-on-month and 7.9% year-on-year.

In contrast Redfin data has housing costs up just 1.3% for the year to December 2022. Now the RedfinRDFN
data is for house prices, but Apartment List’s data on the U.S. rental market shows a similar slowdown, with rental costs up 3.3% year-on-year in January 2023 and slowing. Statistical methods account for most of this disconnect.

Statistical Methods

The reason for this comes down to statistical methods used by the CPI. The CPI takes a weighted average approach to calculate shelter costs, combining panel data from the past 6 months. In contrast, Redfin and Apartment List and most other industry data providers look at more recent pricing. The CPI methodology is argued to create a more robust representation of the housing market by including more properties in the inflation calculation.

That may be true, but it also introduces a statistical lag in the CPI’s estimates of housing costs. That can be a problem at turning points in the housing market as we’re seeing now. The CPI will be slow to reflect falling housing costs, if indeed housing costs do continue to decline, because of the sampling method used.

Supercore Inflation

The Fed is aware of this issue, in fact Jerome Powell has spoken about it. It suggests that measured CPI inflation is likely running a little high currently because of this housing impact. As a reflection of this, the latest buzzword among economists is supercore inflation. That’s what you get if you take U.S. services inflation and strip out housing and energy costs. That’s running considerably lower than the headline inflation numbers. However, supercore inflation is a relatively narrow set of services, representing about 20% of household purchases, as such this has the potential to deviate substantially from overall U.S. price trends. Still the Fed values it currently as a measure of sticky inflation as it tries to assess the level inflation may trend back to over time.

Future Rate Decisions

January CPI data is unlikely to comfort the Fed. Yes, inflation is falling, perhaps more that estimated when adjustments are made for house price calculation methods. Nonetheless, the Fed can still worry that inflation is not declining fast enough and that inflation may remain above the Fed’s 2% goal. That’s why the markets expect more rate hikes from the Fed in the coming months, until there is clear evidence that U.S. inflation is clearly trending back to a more manageable level.