Wednesday, May 17, 2006

CPI and Owner's Equivalent Rent

by Bill McBride on 5/17/2006 10:07:00 PM

MarketWatch has the story: Housing slowdown behind rise in inflation

Beneath the surface of rising core consumer prices over the past two months lies a disturbing trend: The slowing housing market is actually making inflation look worse, economists said.

The housing sector makes up 40% of the consumer price index, which increased 0.6% in April.
In the heady days of the booming housing market, more people were buying homes, and fewer were renting, economists said. Supply and demand kept rents comparatively low, and inflation appeared to be contained -- despite the run-up in home prices. But this virtuous circle is now reversing.

With home prices remaining high and mortgage rates rising, more people are being priced out of the real-estate market and are instead looking to rent. This increased demand is pushing up rents.
At the same time, the supply of rental properties has been constrained, as many former rental properties have been converted into condominiums, said Mark Vitner, senior economist at Wachovia Corp.

"This dynamic, once it begins, is fairly sticky," said John Ryding, chief U.S. economist at Bear Stearns. "This raises the risk of higher inflation going forward."

Perversely, this slowdown in the market is also pushing up the costs of owning a home, at least, the cost as reported by the government.

The way the government computes the CPI has created a distortion that made inflation look tame when home prices were soaring, but is now making inflation look worse as price gains moderate. It's all because the government measures everyone's housing costs -- renters and homeowners by looking at rents, not at the cost of owning.