OER, services prices, and inflation

OER, services prices, and inflation

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*The rise in inflation has been characterized by soaring prices of goods associated with the robust demand for goods and more moderate inflation in services associated with the constrained recovery in the services sectors. Prices of services comprise nearly 70% of both the CPI and PCE price index, and prices of goods are up a bit over 30%.

*The cost of shelter, which is comprised primarily of owner-occupied equivalent rent (OER) and rental costs, is the largest component of measured inflation. OER, the biggest driver of shelter costs, has accelerated only modestly, to 3.8% year-over-year, while the CPI’s measured rental costs have increased to 3.3% despite surging home prices and observed rental costs.

*We forecast measured OER and the rental cost to accelerate to approximately 5.3% by year-end 2022 and remain elevated through 2023, based on a vector auto regression (VAR) model with three variables, the Case Shiller Home Price Index and OER and the rental cost index in the CPI that highlights the historical lags between home prices and OER (Chart 1).

*Services inflation is projected to accelerate, driven by shelter costs, a full recovery of services from the pandemic, and higher wages. The higher services inflation should more than offset anticipated disinflation (or even deflation) in goods, resulting in persistently elevated inflation.

Chart 1. Forecast of OER based on VAR model

Mickey Levy, [email protected]

Mahmoud Abu Ghzalah, [email protected]

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