CPI Inflation Hits 40-Year High, But Even That Number May Be Too Low

Inflation for December in the U.S. hit a 7% annual increase, the highest rate going back to June 1982 when Reagan was U.S. President. However, there may be a problem with the Consumer Price Index (CPI) inflation estimate. It could be understating rising housing costs.

Unfortunately there’s some risk that rocketing housing and rental costs suggested by multiple industry sources and indices may make inflation even higher than the 7.0% annual increase reported for December 2021. That’s because the CPI index has housing costs rising just 4% whereas industry sources see prices up as much as 20%. A major difference.

Housing Costs

As you might expect, housing costs (termed “shelter” in the CPI report) make up a big portion of the inflation estimate. That’s because people typically spend a lot of their budget on somewhere to live, whether that’s buying a house or renting one.

Housing costs make up almost one third of the inflation price index because so much money is spent on housing. Hence movements on house prices can move the inflation rate a lot. So let’s look at some estimates of how house prices are moving.

Housing Cost Estimates – Up +17% to +20%

One estimate of house prices comes from the Case-Shiller house price indices. These have house prices increasing around 17% to 20% for the last 12 months depending on the precise index used, slightly lower for the top 10 or 20 markets, higher for a broader U.S. assessment. Now that’s not quite apples to apples. Since the Case-Shiller series are updated for October 2021, as of the time of writing, so 2 months behind the CPI series. However, that shouldn’t fundamentally change the picture. For example, Zillow’s data has house prices up 19% year-over-year up to November 2021.

Rental Costs – Up +13% to +21%

Now, rental costs shouldn’t deviate that much from house prices changes over the longer term, but Zillow
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has rental costs up 13% for the 12 months to November 2021. Apartmentguide has rental costs up 17% to 21% for the year to December 2021 for 2-bedroom and 1-bedroom apartments respectively. Again, though, a similar picture from all these industry sources, shelter costs up well into double digits.

Differing Industry Estimates, But Nowhere Near +4%

Clearly, you can track shelter costs in different ways and not all series will align perfectly. Still, we have series pointing to housing and rental prices rising around 13% to 21% for 2021 with some variation in what’s being measured and the date of the report whether it’s measuring up to October, November or December 2021.

Yet, the most recent CPI inflation report had the cost of shelter rising just 4.1%. That’s a stark difference from other estimates that have housing costs rising 13% to 21%.

High CPI Weights

Furthermore, this component of inflation really matters. It makes up on third of the CPI inflation index. So if, for example, housing costs are rising at 17%, as an average of the data we’ve just discussed, rather than 4% as in the CPI numbers, then applying the 33% index weight and holding non-shelter costs at the same rate as in the CPI report, that would put overall inflation roughly +4% higher at 11%, rather than 7%.

Yes, 7% inflation is a concern (and one reason the Fed plan to hike rates in 2022), but 11% is pushing historical peak levels. Those sort of numbers are close to rivalling post-war  peak U.S. inflation during the heights of the inflation surges of the 1970s and 1980s.

Some Good News

Even though this is concern, as high inflation is almost never good for economies and financial markets, some good news is that many economists do expect CPI inflation to start to moderate from here as 2022 progresses.

Indeed, the monthly rate of price increase for December 2021 was a bit slower than many month-on-month price increases for 2021. So, even if inflation is set to see a boost as housing price rises may work their way over time into the CPI index, other components could moderate from current levels offsetting some of the more extreme potential increases.

Still even at 7% inflation, which is historically extremely high in a U.S. context, it does appear there is a potential risk that inflation is being understated today as house prices rise far more than the CPI figures appear to suggest.