"How do house prices feed into inflation rates around the world?"
From Bond Vigilantes:
After the collapse in real estate prices in many of the major
developed nations during and after the Great Financial Crisis, housing
is back in demand again. Strong house price appreciation is being seen
in most areas of the US, in the UK (especially in London), and German
property prices have started to move up.
We’re even seeing prices rise
in parts of Ireland, the poster child for the property boom and bust
cycle. I wanted to take a quick look at what rising house prices do for
inflation rates. Not the second round effects of higher house prices
feeding into wage demands, or the increased cost of plumbers and
carpets, but the direct way that either house prices, mortgage costs and
rents end up in our published inflation stats. Also, the question about
whether central banks should target asset prices is another debate too
(there’s some good discussion on that here).
There is no simple answer to the question “how do house prices feed
into the inflation statistics”. It varies not just from country to
country, but also within the different measures of inflation within one
geographical area. But given central banks’ rate setting/QE behaviour is
determined by the published inflation measures it’s important to
understand how house prices might, or might not, drive changes in those
measures.
The US
“Shelter” is around 31% of the CPI which is used to determine the
pricing of US inflation linked bonds (TIPS), but just 16% of the Core
PCE Deflator, the measure that the Federal Reserve targets. The PCE is a
broader measure, with much bigger weights to financial services and
healthcare, so shelter measures therefore have to have a smaller weight
in that measure. The CPI shelter weight looks high by international
standards. For the Bureau of Labor Statistics, the purchase price of a
house is not important except in how it influences the ongoing cost of
providing shelter to its inhabitants. The method that the BLS uses to
determine what those costs might be is “rental equivalence”. It surveys
actual market rents, and augments this data by asking a sample of
homeowners to estimate what it would cost them to rent the property that
they live in (excluding utility bills and furniture). You can read a
detailed explanation of this process here.
In both the CPI and PCE, pure market rents are given around a quarter
of the weight given to OER, Owners’ Equivalent Rent. There are problems
with this – and not just with the accuracy of the homeowners’ rental
guesses. Having rents and rental equivalence in the inflation data
rather than a house price measure means that you can have –
simultaneously – a house price bubble, and a falling impact from house
prices in the inflation data. We’ve seen times when a speculative frenzy
means house prices rise, but the impact of that speculation is
overbuilding of property (just before the 2008 crash there was 12 months
of excess inventory of houses in the US compared to a pre-bubble level
of around 5 months) leading to falling rents. The reverse happened as
the US recovered. House prices continued to tank, but because of a lack
of mortgage finance more people were forced to rent, pushing up rents
within the inflation data.
The UK
How house prices feed into the UK inflation data depends on whether
you care about CPI inflation (which the Bank of England targets) or RPI
inflation (which we bond investors care about as it’s the statistic
referenced by the UK index linked bond markets). House prices directly
feed into the RPI, but because house prices have little direct input
into the CPI, the recent trend higher in UK property will lead to a
growing wedge between the two measures
– good news for index linked bond investors!....MUCH MORE
