Cost of Living Rooms

Shelter costs are keeping inflation measures elevated.

The importance of the housing market has led us to focus on it across many dimensions. We have discussed its short supply, the role of mortgages as a defense against inflation and promises of greater residential investment. Today, housing has captured our attention as a consequential and frustrating driver of inflation.

Shelter costs followed headline inflation up in this cycle, but have remained stubbornly elevated even as most other components improved. The majority of U.S. households own their homes; in the consumer price index (CPI), their monthly costs are captured by a concept called owners’ equivalent rent (OER). The measure is theoretical; it does not use actual house prices or interest rates, which combine to drive mortgage costs. Its impact on inflation is significant, as OER represents over 25% of the CPI basket (and combined with rent, the shelter category exceeds 35% of the CPI).

US CPI Inflation

High housing inflation is casting more attention on these measures, and a divergence in their growth rates in January was alarming. The rent and OER indices usually move in tandem, as they are closely related. In January, the two measures grew at starkly different rates.

As part of routine annual benchmarking, the weights in the OER formula were rebalanced to add 5% more weight toward single-family detached housing. Rents on these units have been growing more rapidly than they have for apartments, which created the jump in inflation. The weights are now fixed for the year ahead, and further divergence is unlikely—at least, until the next reset.