July 19, 2006 (Prices Byte)
Rising Rents Propel Inflation Higher in June
July 19, 2006
By Dean Baker
The overall CPI showed a relatively mild 0.2 percent rate of inflation in June, held down by a 0.9 percent drop in energy prices. However, the core (excluding food and energy) CPI rose by 0.3 percent for the fourth consecutive month. The June rise puts the annual inflation rate in the core at 3.6 percent over the last three months, a full percentage point above the 2.6 percent rate over the last year. The annual inflation rate in the overall CPI has been 5.1 percent over the last quarter, up from 4.3 percent over the last year.
Rising rents were again the main factor driving up the core inflation rate as owners’ equivalent rent and rent proper both rose by 0.4 percent in June. Over the last three months these components have risen at 5.6 percent and 4.2 percent annual rates, respectively.
These increases are a direct fallout from higher interest rates, which are pushing potential homebuyers back into the rental market. While rental vacancy rates are still at relatively high levels, they are considerably lower than the all-time highs reached two years ago. Meanwhile the vacancy rate among ownership units has risen to a record high. While high vacancy rates are putting downward pressure on sale prices, it is likely that many of these units will eventually show up in the rental market, as frustrated owners feel the need to maintain a cash flow until they can sell a house or condo.
It is worth noting that even the sharp rise in housing costs shown in the CPI in recent months may understate the increase as perceived by consumers. There have been widespread reports of sharp increases in the price of homeowners’ insurance, especially in storm prone areas like Florida and the Gulf Coast. The CPI shows the price of insurance actually falling by 1.4 percent over the last year. This gap is explained by the fact that the CPI insurance component only counts the net cost (premiums minus payouts) of insurance, not the actual premium. Since the factor driving costs has been higher payouts, this does not show up as higher insurance prices in the CPI.
Because so much of the reported inflation is due to housing, there are large differences across cities and regions. For example, the CPI for the Miami and New York areas rose by 5.8 and 5.6 percent over the last year, respectively. The CPI for Chicago rose by just 2.6 percent over the same period.
While the upturn in rental prices has been the biggest factor behind the recent acceleration of inflation, there has been some evidence of accelerating inflation in most components. For example, the apparel index rose at a 2.2 percent annual rate in the first half of the year after consistently declining over the last decade. Recreation prices rose at a 2.0 percent annual rate in the last six months, after increases averaging just 0.9 percent over the prior two years.
The evidence of inflation is showing up at earlier stages of production also. The core finished goods index increased at a 3.1 percent annual rate in the first half of 2006 compared to a 1.4 percent rate in 2005. The core intermediate goods index increased at a 7.8 percent annual rate, compared to a 4.8 percent rate in 2005. Crude goods prices have soared in recent months, with the core index rising at a 63.1 percent annual rate over the last quarter. Import prices are also rising more rapidly, with non-fuel imports prices rising at a 6.1 percent rate over the last quarter.
The June price reports provide more evidence that inflation is creeping higher. Furthermore, productivity growth appears to be slowing to a 2.0 - 2.5 percent range (from its extraordinary 3.7 percent rate in the years 2002-04), and nominal wage growth appears to have accelerated to above 4.0 percent. All of this evidence suggests that inflation is likely to be somewhat higher in the months ahead. While this is hardly runaway inflation, the rates on the horizon may be outside of the Bernanke Fed’s comfort zone.
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.