Friday, December 17, 2004

Housing Prices Hold Down November Inflation

Inflation in the core non-rent CPI has been 3.5 percent over the last quarter.

By Dean Baker, CEPR

The overall and core (excluding food and energy) CPI both rose by 0.2 percent in November, largely in line with expectations. This brings the annual rate of inflation over the last three months to 3.9 percent, somewhat above the 3.5 percent rate for the last year. The annual rate in the core over the last three months has been 2.7 percent, up from a 2.2 percent rate over the last year. Both the inflation rate of the last quarter and the last year are running far above the rate of hourly wage growth, which has been approximately 2.5 percent over both periods.

While the inflation rate is clearly rising, passing on cost pressures at earlier stages of production, it important to realize the extent to which weakness in the rental market is restraining inflation at the moment. The two rental indexes, rent proper and owners' equivalent rent, together account for 29.5 percent of the weight of the whole CPI, and 37.6 percent of the weight of the core index. The combined inflation in these two components was less than 0.1 percent in November.

The annual inflation rate in the two rental components over the last three months has been just 1.4 percent. The annual inflation rate over the last three months in the core CPI, excluding the rental components, is almost 3.5 percent. Since the rate of rental inflation has slowed sharply in recent months, it has concealed the extent of the increase in core inflation.

This is important for two reasons. First, price pressures are far more prevalent than the overall or core data indicate. Second, the growing weakness in rental prices is further evidence of the unsustainable nature of the recent run-up in home sale prices. A glut in rental housing is putting more downward pressure on rents, even as home sale prices have continued to rise at a rapid pace. Rents and home sale prices have always moved together, with any divergences being reversed through time. With rents continuing to lag inflation by a greater margin, it becomes increasingly certain that the correction will come through a fall in house prices.

Apart from the weakness in rents, the only other especially noteworthy item in the November CPI was a 0.7 percent jump in new car prices. This increase presumably reflects erratic pricing behavior, and will probably be reversed in part in coming months. However, the fall in the dollar is placing upward pressure on the price of imported cars and parts. This should lead to increases in car prices for the foreseeable future, in contrast to the modest declines in car prices over the last eight years.

Inflationary pressures continue to build at earlier stages of production. Prices in the overall finished goods index increased by 0.5 percent in November, bringing the increase over the last year to 5.0 percent. While this rise is largely attributable to rising energy prices, the core index has risen by 1.9 percent over the last year, and at a 3.4 percent annual rate over the last quarter.

The overall intermediate goods index rose by 0.8 percent in November and is now 9.8 percent above its year ago level. The core intermediate goods index stands 8.0 percent above its year ago level, and has risen at a 5.4 percent annual rate over the last quarter. The overall crude goods index is 25.5 percent above its year ago level, almost identical to the 25.6 percent rise in the core index over this period.

The November price data provide further evidence that inflationary pressures are building at earlier stages of production and that these pressures are showing up in the overall CPI. The weakness of the rental housing market has largely concealed the extent to which consumer prices in most areas are rising. Consumer inflation is likely to rise still further in the months ahead, especially if the weak productivity growth of the third quarter turns out not to be a fluke.