Shelter Inflation Expected to Slow Significantly

New research from the Federal Reserve suggests that shelter inflation, which refers to the rise in housing costs in the U.S., is anticipated to slow down over the next 18 months. This development is expected to assist in bringing overall inflation to desired low levels.

According to economists at the San Francisco Fed, changes in the housing market indicate a potential substantial easing of pressure from shelter inflation. They state in their report, "The forecasts we present... indicate that future shelter inflation may decline considerably, reflecting the signals of slowing in recent rental markets."

The economists further explain that their results imply a reduced risk of unexpected increases in shelter inflation, especially with the rapid rise in interest rates since early 2022.

Over the past year, the Fed has concentrated on its objective of lowering consumer price inflation to 2% by increasing its benchmark interest rate to a 22-year high. In June, consumer inflation rose by 3%, with shelter accounting for 70% of this increase. Additionally, rents have escalated by 8.3% within the last year.

However, the rise in mortgage rates caused by the Fed's interest rate hikes has resulted in a significant slowdown in home buying demand. While there is still limited housing availability, there is a surge of rental apartments entering the market, which is expected to put downward pressure on rents.

RealPage Market Analytics reported that approximately 376,000 apartments were introduced to the market in the second quarter of this year. Data from private-sector sources such as Apartment List also show that annual rent growth fell by 0.7% in July.

It is important to note that the Fed researchers have highlighted certain caveats to their forecast. The wide range of errors is attributed to significant uncertainty within the forecasting models. Furthermore, since the models primarily rely on data from the unusual pandemic period when home prices and inflation experienced dramatic increases, caution must be exercised.