June 14, 2006 (Prices Byte)
Rising Housing Costs Push Inflation Higher in May
June 14, 2006
By Dean Baker
Both the overall and core (excluding food and energy) CPI showed somewhat higher inflation in May than had generally been expected. The overall CPI rose by 0.4 percent in May, bringing the annual rate over the last three months to 5.7 percent, well above the 4.2 percent rate for the last year. The core inflation rate was 0.3 percent for the third straight month, bringing the annual inflation rate in the core for this period to 3.8 percent, more than a full percentage point above the 2.4 percent rate for the prior year.
The biggest factor behind the acceleration in the core inflation rate has been the more rapid growth in rents, both owners’ equivalent rent (OER) and rent proper. The OER component rose by 0.6 percent in May, the largest increase since a 0.7 percentage point jump in August of 1990. The May increase brought the annual rate of inflation in the OER component to 5.4 percent for the last three months. This component alone accounts for more than 30 percent of the weight of the core CPI. The rent proper index rose by 0.3 percent in May, bringing the three- month inflation rate in the rent index to 4.0 percent.
While some of the acceleration in the rent component is probably anomalous, it is likely that there is some real tightening in the rental market. The run-up in home sale prices hugely outpaced the increase in rents over the last nine years. The recent rise in interest rates is now making these high priced homes increasingly unaffordable, therefore more people are opting to rent rather than buy. (In the last few quarters, the rental vacancy rate has begun to decline, while the vacancy rate for ownership units has reached record highs.) This process is likely to continue until house sale prices begin to fall, bringing them more in line with rents. This means that rental prices are now likely to be a force pushing inflation higher, rather than restraining overall inflation.
The May data for most other components is consistent with a picture of moderately accelerating inflation. The medical care index rose by 0.3 percent in May and the recreation index rose by 0.2 percent, bringing their respective inflation rates over the last three months to 4.5 percent and 3.3 percent. The latter is an increase of 1.7 percentage points compared to the 1.6 percent inflation rate for the last year. New car prices fell by 0.3 percent in May and have fallen at a 1.7 percent annual rate over the last three months. This is probably a somewhat faster decline than the trend rate for autos, and will likely be reversed in the months ahead.
Inflationary pressures continue to build at earlier stages of production as well. The overall finished goods index rose by 0.2 percent in May, but the core index increased by 0.3 percent. The overall and core intermediate goods index both rose by 1.1 percent in May. The core intermediate goods index has risen at a 6.9 percent annual rate over the last three months. The overall crude goods index rose by 2.0 percent in May, while the core index rose by 6.2 percent. Even import prices are rising more rapidly, with the non-fuel import index rising by 0.7 percent in May. With the dollar likely to continue its decline, import prices are likely to continue to rise.
The May price data provides grounds for concern on several fronts. It seems clear at this point that inflation is on the uptick throughout the economy. At the moment, inflation is substantially outpacing the rate of wage growth. This will limit the ability of workers to sustain their current levels of consumption, especially with the opportunities to borrow against home equity rapidly disappearing. However, with labor markets still reasonably tight, it is likely that workers will be able to push for higher nominal wages. While this will help to sustain demand, it will lead to more inflationary pressure, especially in an environment where productivity growth appears to be weakening.
Dean Baker is a co-director of the Center for Economic and Policy Research in Washington, DC
CEPR’s Prices Byte is published each month upon release of the Bureau of Labor Statistics’ reports on the consumer price and the producer price indexes.