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The big problem in Tuesday’s CPI report was shelter and it could remain the big problem for years.
About two-thirds of January inflation rise was from shelter and that component was also a key driver during the post-pandemic period. At that point, it was because of low rates and the rise of remote work. In the future, it could be about high mortgage rates and low housing supply.
There’s a conundrum brewing in central banking. Hiking rates directly feeds into inflation by making mortgage costs higher. It also makes home construction harder because people can’t afford homes, builders can’t borrow and builders are wary of volatility in home prices.
It’s beginning to look like we could have a bounce in
shelter costs that would leave policymakers reluctant to cut rates. The problem is that waiting longer to cut rates, means home builders will wait longer to add supply.
The US benefited from a decade of low home prices after the financial crisis. The dividend from that was low interest rates but now the US is increasingly supply constrained and rates are high. Keeping rates high will continue to suppress needed new home construction and further push up prices.
While rate hikes ultimately put pressure on inflation, they can be counterproductive in housing. As we learned in the pandemic, monetary policy can’t fix supply issues.
For the US, I don’t think this is too big of a problem but in Canada and in other countries that are already struggling to build homes to due structural issues in the economy, zoning and regulation; this could prove to be a major headache for central bankers..