Rents Are Likely to Be the Last Domino to Fall in the Global Inflation Battle

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(Bloomberg) — Surging rents across many developed economies are proving to be a stubborn hurdle for central banks as they struggle to nail down inflation once and for all this tightening cycle. 

In the US, UK, Canada and Australia, rapidly rising housing costs — which have a hefty weighting in consumer price index baskets — are preventing inflation from declining closer to central banks’ targeted levels. The danger is that workers will demand even fatter pay checks to deal with the cost-of-living squeeze, undermining the inflation fight even further.  

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The result: The disinflationary momentum seen for most of last year has all but stalled in some developed economies. This results in financial markets either scaling back bets on rate cuts, as was the case in the US, or reviving the chances of further rate hikes, as is the case in Australia.

“Rents, like inflation, are a more lagging indicator of the economic cycle and will be one of the last things to come down,” said Shane Oliver, chief economist at AMP Ltd. in Sydney. The problem is far from uniform and less problematic in continental Europe, Oliver said, and is even worse in countries with rapid immigration programs and construction shortages.

Australia meets both criteria. Reserve Bank Governor Michele Bullock said on Tuesday that strong immigration in recent years has “certainly increased pressure on the property market and that is having an impact on rents,” the RBA said in its quarterly update published the same day of economic forecasts that rental inflation is expected to “remain high” until at least mid-2026.

Australia’s decline in core inflation since the start of 2023 has “come to an abrupt halt”, partly due to rising rental costs, said Phil Odonaghe, an economist at Deutsche Bank AG. Data from real estate consultancy CoreLogic Inc. showed this week that Australia’s average rent hit a record high of A$627 ($414) a week in April, rising 8.5% from a year earlier.

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“If strength in one segment of the CPI lasts long enough, there is a risk that inflation expectations will rise, which will impact the overall CPI,” he said. “The risk of this happening is anything but trivial.”

Compared to last year, rental inflation rose 7.7% in the first three months of 2024, remaining at its highest level in the 30 years the RBA has been targeting inflation. Excluding housing, Australia’s annual CPI was 3.2% – 0.4 points lower than the overall figure and within sight of the Bank’s 2-3% target.

Rising rents are also a major problem for British families and a key voter issue ahead of the general election expected later this year.

UK rental prices – up by a fifth since 2022 – are now rising at their fastest pace ever after high mortgage costs forced would-be home buyers to return to the rental market, exacerbating a housing shortage caused by decades of underinvestment. According to an analysis by the Resolution Foundation, rents are expected to rise 13% over the next three years, faster than wage growth.

However, the Bank of England still has other problems. Gov. Andrew Bailey and his colleagues have turned their focus to wage growth and services inflation that remain too high for comfort. If these metrics cool and goods inflation is already below 1%, they could offset rising rental costs and bring inflation back to the 2% target.

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“Given the importance of rents in the CPI basket, if they continue to rise faster than the BOE’s target, they will clearly increase pricing pressures,” said Tera Allas, director of research and economics at McKinsey in the UK. However, BOE officials “may be more concerned about those items and sectors where inflation is clearly driven by domestic wage or profit pressures, such as hospitality.”

Economists widely expect Britain’s central bank to keep interest rates at a 16-year high of 5.25% on Thursday, with investors looking for clues as to whether policymakers will use June or August as an opportunity to cut see.

Rental costs also remain a focus for the Federal Reserve as officials wait for a window to reduce borrowing costs. Rent accounts for around a third of the CPI inflation index, making it one of the biggest price drivers. The core CPI, which excludes food and energy costs, beat forecasts for the third straight day in March, partly due to rent increases.

Federal Reserve Chairman Jerome Powell said he expected falling rental costs to eventually be reflected in broader price data, allowing policymakers to cut interest rates at some point.

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“I’m confident that this will be reflected in measured inflation as long as market rents remain low,” Powell told reporters last week after the Fed’s two-day policy meeting. The central bank kept interest rates at their highest in more than two decades while signaling a desire to cut them when it is confident inflation is under control. Traders are currently betting on at least a 25 basis point rate cut this year.

Still, Powell may have to wait. Households’ expectations of changes in rental costs have increased significantly compared to last year. Rent costs are expected to rise 1.5 percentage points to 9.7% next year, according to a New York Fed survey released Monday.

Read more: Rents are the Fed’s ‘biggest stumbling block’ in curbing US inflation

A shortage of housing – partly due to high interest rates – has kept prices high.

“Housing is a real problem in the United States because of the enormous shortage of affordable housing and, in part, because of high interest rates,” Treasury Secretary Janet Yellen told Bloomberg News. “However, I strongly believe – I think it is very likely – that the cost of accommodation, which has driven up inflation, will come down.”

While inflation could ease from here, it is unlikely to see a significant slowdown, said Stephen Stanley, chief U.S. economist at Santander US Capital Markets LLC. “If this forecast is correct, the FOMC has a lot of work ahead of it to get core inflation back to 2%,” he said.

– With assistance from Christopher Condon.

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