Inflation cooled significantly last month, representing arguably the most promising news for the housing industry since the Federal Reserve began instituting aggressive price control measures 16 months ago. But it’s just one report, and the Fed is likely to stay the course until signs point to a ‘break’ in the labor market, economists said.
After recording a 4.0% annual increase in May, the CPI rose just 3.0% year over year in June, before seasonal adjustment, according to data released Tuesday by the Bureau of Labor Statistics (BLS). Excluding food and energy, the CPI rose 0.2% from the prior month.
The so-called core measure — which economists view as the better indicator of underlying inflation — advanced 4.8% from last June, the lowest since late 2021 but still well above the Fed’s target.
This is the smallest 12-month increase since the year ending March 2021 and the 12th consecutive month of inflation declines.
Indexes that increased in June include shelter, motor vehicle insurance, apparel, recreation, and personal care. The indexes for airline fares, communication, used cars and trucks, and household furnishings and operations were among those that decreased in June.
Shelter, which is the largest category, also posted a sizable increase, rising 7.8% year over year (down from 8.0% in May) and accounting for more than 70% of the total increase in the all items less food and energy index which was up 0.2% in June.
But the shelter inflation figure is highly imperfect. The BLS’s CPI metric lags asking rents because the CPI measures in-place rent, and because most renters see a change only once per year, the index lags significantly from asking rents on new leases. Peak rent inflation was between May 2022 and February 2023, but has declined in subsequent months and is expected to continue to do so.
An index tracking the rent of primary residences slowed to a 0.46% change in June, the weakest increase since March 2022.
“Despite the positive inflation report, the Fed likely will resume its rate hikes when it meets later this month, remaining committed to raising interest rates until the magical 2% inflation target is met,” said Lisa Sturtevant, chief economist at Bright MLS.
The problem is that housing costs, which account for a large share of the inflation picture, are not coming down meaningfully in the CPI. In June, the index for shelter accounted for 70% of the increase in the CPI. Rents were up 8.3% in June, while owner costs rose 7.8%.
Unfortunately, the Fed does not have the right tools to tackle high housing costs in the U.S, Sturtevant noted. Initially, higher rates did cool housing demand. But because rates had been pushed so low by the Fed during the pandemic and then increased so quickly, the Federal Reserve’s rate increases not only reduced housing demand—as intended—but also severely limited supply by locking homeowners into homes they would have otherwise listed for sale.
“Housing should not be treated like other goods and services in the CPI’s basket. A home is not a dozen eggs or a flat screen tv or a trip to the beach. Pushing rates higher without a strategy for increasing supply in the market will not cause housing costs to fall—until the Fed has gone too far by sending the economy into a recession and decimating demand through job and income losses,” said Sturtevant in a statement.
In the meantime, with inventory hovering around record lows and mortgage rates north of 7%, a generation of Americans is being forced to the sidelines, excluded from the ability to build wealth through homeownership.
Nevertheless, there are signs the housing industry is turning a corner. “Low inflation means low mortgage rates. Therefore, decelerating consumer prices could steadily lift home sales and increase home production in a few months,” said Lawrence Yun, chief economist for the National Association of Realtors. “Moreover, with so many empty apartment units under construction, rents could plateau by this time next year.”
Yun, who’s been critical of the Federal Reserve’s series of rate hikes, said the monetary policymakers “misjudged the early strength of inflation, which got out of control. Now it could misjudge on the economic front.” He said the body is too focused on lagging indicators like jobs rather than early indicators like future inflation and commercial leasing activity.
“They should look ahead and stop raising interest rates,” he said.