Although rent increases have tapered off in recent months, the index for overall housing costs will likely keep rising at a markedly fast pace through the first half of this year, according to a new paper coauthored by Federal Reserve Bank of Boston economist Christopher Cotton. The growth rate will then likely slow down but remain high through 2024 before decelerating more.

Cotton and his coauthor, Boston Fed research assistant John O’Shea, obtain these forecasts by looking at how quickly rental prices traditionally pass through into inflation measures. Notably, the paper, titled “Forecasting CPI Shelter under Falling Market-Rent Growth,” takes a bottom-up approach to the analysis, using market-rent data from 16 U.S. metropolitan areas instead of aggregated national data.

The paper’s forecast of a rapidly rising housing-cost index is based on the premise that the index has yet to reflect the increases in rents seen in the market-rent data. “If CPI shelter has not yet incorporated past high market-rent growth,” the authors write, “then CPI shelter will be higher in the future as it incorporates this high past market-rent growth.”

The CPI is the Consumer Price Index, the price gauge financial markets follow most closely. In the CPI, housing is designated as “shelter.” Shelter prices are measured as the rent that tenants pay and the rent that homeowners would pay to live in their houses if they didn’t own them. The authors refer to the index for shelter prices as CPI shelter.

According to the authors’ forecast, CPI shelter will increase 5.9% from September 2022 to September 2023 and 3.9% over the ensuing 12 months. By contrast, from 2000 through 2019, CPI shelter rose an average of 2.7% annually.

CPI shelter lagged market rents when they were rising fast

The authors base their forecast of rapidly rising CPI shelter on two trends: (1) Although market-rent growth has slowed recently, it was substantially faster than CPI-shelter growth throughout 2021 and the first half of 2022, and (2) CPI shelter usually catches up with market rents.

The authors explain that CPI shelter tends to lag market rents because of the way that the U.S. Bureau of Labor Statistics constructs CPI shelter. The BLS gathers information for the index through its Consumer Price Index Housing Survey. The survey measures average rental prices for all renters – new and existing – whereas market rents measure only rental prices for new tenants. The authors note that landlords tend to raise the rents of current tenants slowly, so an index that includes current tenants’ rents is going to be lower than one that excludes them.

The market-rent data come from the Single-Family Rent Index produced by CoreLogic, a company that, among other analytical services, provides estimates of market rents in major U.S. metropolitan areas using the latest rental-price listings. For their analysis, the authors look at 16 metropolitan statistical areas, or MSAs, for which CoreLogic market-rent prices and CPI shelter are both available. With that data, they estimate how CPI shelter will move in the future based on how market rents and CPI shelter have moved in the past and the difference between the levels of CPI shelter and market rents.

The authors note that by using MSA-level data instead of aggregated national data for their analysis, they can control for factors related to an MSA. “And it gives us a much larger number of data points, which can improve our estimates,” the authors write.

Housing costs have a strong effect on the Consumer Price Index

Shelter prices are the largest component of the CPI. They make up 33% of the headline CPI, which includes prices across all consumer goods and services, and 42% of the core CPI, which excludes food and energy prices.

The authors show the extent to which shelter prices can affect the CPI. Shelter prices rose 0.75% from August to September 2022, the last month for which the authors had data when they wrote the paper. If the headline CPI did not include shelter prices, they write, it would have grown 0.21% in that month, which would amount to 2.5% annually. That’s close to the Federal Reserve’s 2% inflation target. Instead, the headline CPI grew 0.39%, which is 4.8% when annualized.

“It is therefore important to understand how CPI shelter will change in the near future to better understand inflation dynamics more broadly,” the authors write.

If CPI shelter does increase 5.9% from September 2022 to September 2023, as the authors forecast, and 3.9% over the ensuing 12 months, the headline CPI will be 1% higher over the first 12-month period and 0.4% higher from September 2023 to September 2024 compared with what it would be if shelter prices grew at the pre-pandemic pace of 2.7%. The core CPI will be 1.3% and 0.5% higher.

Even if rents fall, housing costs could affect inflation for months

Some analysts forecast that market rents will grow slowly or fall in the near future. The authors’ estimate of a 5.9% increase in the shelter cost index does not fully capture such a trend. But the paper also looks at a scenario in which rent prices fall over the next two years.

Their estimation shows that if market rents were to decline 1% annually through September 2024, CPI shelter would still grow 5.3% from September 2022 to September 2023. Then over the subsequent 12 months, the growth rate would fall to 2.4%, which is lower than the pre-pandemic average rate of 2.7%.

“Under low market-rent growth,” the authors write, “we find that CPI shelter will place considerable upward pressure on inflation through September 2023, but the impact will then diminish.”

View the paper.