Rising rents push inflation higher, derailing the Fed's rate cut plans

Rising rents across the country are complicating the Federal Reserve's fight against inflation, and could put hoped-for interest rate cuts in peril.

While the consumer price index (CPI)—a key inflation benchmark—was unchanged at 3.3% in the year to May, the cost of shelter is a whole 'nother story.

Last month, rent inflation (known as rent CPI) hit 5.4%—thanks to growing rent prices across 80 of America's 100 largest cities, according to data from Apartment List.

The silver lining is that price growth appears to be cooling.

According to Apartment List, the pace of rent growth in May has slowed when compared with previous months, even though this is one of the busiest times of year to move.

Year-on-year rent growth nationwide has also contracted by 0.8% and has remained negative for almost 12 months. But given the national median has surged by over $200 compared with two years ago, it might not feel like it.

According to the company's forecasters, "sluggish growth indicates the market is headed for another slow summer," and this could offer much-needed relief for tenants.

While rent CPI has been "steadily cooling" since last spring, the report warns that it's still dragging overall inflation figures up.

"As shelter inflation continues to trend down, it will help ease overall inflation as well, but it will take time for shelter CPI to fully metabolize the shock to market rents," it added.

All of this has created a headache for Fed chair Jerome Powell, who has left interest rates unchanged once again—creating fresh pain for tenants and homeowners alike.

"The best thing we can do for the housing market is to bring inflation down so that we can bring rates down so that the housing market can continue to normalize," he said at a news conference on 12 June.

"A last-mile problem"

Last week, the Federal Reserve Bank of Boston said Powell is facing a "last-mile problem" in his quest to get inflation back to 2%.

Boston Fed economist Christopher blames housing costs, as the price of shelter "accounts for a substantial share of the indexes used to measure overall inflation."

According to Cotton, shelter made up 36.1% of CPI as of April—and if this item was excluded, inflation would have been within a range of 1.8% to 2.4% between July and February.

He also noted that rent CPI tends to suffer from a time lag because it reflects what everyone is paying, and not just the rental agreements struck by new tenants.

Cotton's analysis also showed that shelter prices have "remained significantly above their pre-pandemic trend in recent months" despite cooling inflation.

"Looking ahead, continued rapid growth of shelter prices could make it difficult for the Fed to achieve its target inflation this year," he wrote.