February’s CPI Inflation Numbers Put Focus On Home Prices

12-month U.S. inflation for February came in at 6.0% and 5.5% once food and energy are stripped out. That’s broadly in line with expectations but well above the Fed’s 2% goal. On a month on month basis February’s inflation was 0.4% or 0.5% without food and energy. That supports the narrative that inflation is not declining quickly, despite easing from peak levels of summer 2022.

Part of the reason why inflation remains high is home prices. Shelter costs ran at 0.8% month-on-month for February and 8.1% year-on-year per the CPI’s data. The CPI’s measurement is at odds with other industry data sources due to calculation methodology.

Zillow estimates home values are up 6.8% year-on-year to February. Redfin has house prices up 1.4% year-on-year to January. The S&P/Case Shiller National Home Price Index has prices up 5.8% for the year to December and on a declining trend, February’s data may come in lower. Zillow is the only one of these other data providers showing data up to February at this point, but most other estimates are below the CPI’s calculation of shelter costs. It’s not just home prices, Rent.com has rental prices up 2.4% year-on-year to January 2023, the smallest increase in 20 months. All these figures are significantly below the CPI’s 8.1% number.

This is likely a reflection of how the CPI calculates shelter costs, they use a panel approach sampling over a period of six months, which introduces a lag to current housing costs. To the extent that the CPI is looking at data on home prices from up to six months ago, it means they haven’t picked up some softness in home prices since the summer. It now means that inflation could be overstated in CPI data. This because shelter costs make up over a third of the inflation index weighting. It is also particularly relevant at turning points in house prices as we may be seeing currently. That also, correspondingly, implies that inflation was understated at peak levels, as the run up in home prices at that time wasn’t fully captured.

The Fed is aware of this issue, and Fed Chair Jerome Powell has said he expects shelter costs to moderate in CPI data this year. Assuming that happens, the inflation picture could look different.

Still, the timing is uncertain. Illustratively, if shelter costs were flat in the CPI data, then monthly inflation would be running at a level much closer to the Fed’s target, although annual inflation would still some take time to trend down. Even assuming flat monthly shelter costs may be inaccurate at a time when industry sources see declining home prices and rents.

Today’s data won’t reassure the Fed as inflation remains well above their target and is not falling as fast as hoped. Still the unique treatment of shelter costs within the CPI calculation is increasingly responsible.

Nonetheless, the Fed’s decision at their next meeting to set interest rates on March 22 is further complicated by the banking crisis. The Fed had hinted that they were on target for a meaningful rate increase, but recent disruption in the banking sector including the failure of Silicon Valley Bank and Signature Bank has called that into question as the Fed may not want to cause further disruption depending on how issues in the banking sector evolve. Interest rate futures are currently calling for a 0.25 percentage point increase as most likely, with some chance the Fed holds rates steady. That’s down from meaningful expectations of a 0.5 percentage point rise last week.