Inflation has been cooling, and a big part of why is that rent increases have as well. That is also why inflation is likely to keep going lower in the months ahead.
Tuesday’s inflation report from the Labor Department showed that overall consumer prices were up 3.2% from a year earlier in October, while core prices, which exclude food and energy prices in an effort to better track inflation’s underlying trend, were up 4%. That core increase, while still obviously too high, was the smallest since September 2021, and a lot nicer than the 6.6% logged in September of last year.
Shelter costs, which account for about two-fifths of the Labor Department’s measure of core spending, have played a large role in the decline in core inflation. Last month they were up 6.7% from a year earlier, versus a recent peak of 8.2% in March. Those shelter costs are in turn mostly driven by rent prices. This is because the Labor Department uses rent prices to calculate “owners’ equivalent rent”—what it estimates people would need to pay if they rented homes equivalent to ones they own. The Labor Department’s measure of rents was up 7.2% from a year ago last month, versus 8.8% in March.
Zillow data show that inflation in the prices on newly signed leases peaked earlier, and has come down more quickly than the Labor Department’s rent measure. Zillow’s index of national rents was up 3.2% versus a year earlier in September. The increase peaked at 16.1% in February of last year—13 months earlier than the Labor Department’s measure.
The difference here is that the Labor Department’s measure of rents reflects not just rents on newly signed leases, but leases that were signed a while ago. So it takes time for cooling rent inflation to show up. Fed policy makers, private economists and investors are all fairly well-versed in this issue by now, but there is still an open question: How fast will the Labor Department’s rent-inflation measure decline, and where will it end up?
The Zillow rent index can help provide a rough approximation. As a first step, instead of comparing monthly values to their year earlier level, and on the view that leases are for a year or two, take its average value over the past 18 months and compare that to the average over the prior 18 months. Do that, and the September value is 15.6% higher than the prior period, versus a January 2023 peak of 18%. Chart this versus the year-over-year change in the Labor Department’s rent prices, and the two series are quite correlated.
As for a forecast, if you assume that the monthly values for the Zillow index will advance at the same pace in the future as they have over the past year, then the change in the adjusted Zillow index will drop by around half to 7.3% by next September. And if that happens, a simple regression implies the Labor Department’s measure of rent inflation would be a bit more than half as high as it was in October.
Is this what will happen? Of course not exactly. But it sure looks like the Labor Department’s measure of rent inflation, and by extension shelter inflation, has nowhere to go but down.