Housing inflation will need to come down before the Fed can think about cutting rates
With multiple signposts showing that inflation is receding, Federal Reserve officials will spend at least part of their summer looking at one key final hurdle to be crossed, Bank of America pointed out. Housing costs have been at the center of an inflation picture that has vexed policymakers, who expected rents and leases to start drifting downward. Instead, shelter costs have stayed elevated and kept the Fed from having enough confidence to lower interest rates, despite encouraging trends in the past two months. “The April and May inflation reports are welcome and are unambiguously good news following the three undeniably bad inflation prints to start the year,” Bank of America economist Michael Gapen said in a recent note. “However, a change in Fed policy will require more than one or two good reports.” Following last week’s Federal Open Market Committee, or FOMC, meeting , policymakers decided to hold their benchmark overnight borrowing rate at the 5.25% to 5.5% range. In its post-meeting statement , the committee noted “modest further progress” on inflation but indicated that members were still awaiting “greater confidence” that inflation is moving toward the Fed’s 2% target before they would cut rates. Gapen pointed out shelter inflation rose an average of 0.4% a month this year as measured in the consumer price index . Services prices excluding housing rose 4.7% on a 12-month basis in May, he added, a pace inconsistent with the Fed’s 2% goal. With shelter inflation “sticky” at a 5.4% year-over level, Gapen said it could be months before “greater confidence” is achieved. “We think the Fed is unlikely to achieve the confidence it needs to begin rate cuts until shelter inflation takes a step lower,” he said. “We have this happening in our forecast beginning in August and the Fed could see three of these readings heading into the December meeting, when we think it enacts its first — and only — rate cut this year. To be sure, the Fed doesn’t use CPI readings as its guidepost for monetary policy. Instead, it relies primarily on the Commerce Department’s measure of personal consumption expenditures prices , an index that is less reliant on housing in its inflation readings. Monthly housing inflation readings in the PCE measure have been running at either 0.5% or 0.4% since March 2023. Importantly for the Fed, though, the “super core” measure that excludes food, energy and housing services has been at a tame rate, up just 2.1% from a year ago. Fed Chair Jerome Powell , at his post-meeting press conference Wednesday, noted that housing is just one input into how the Fed will proceed on policy. “We’re not looking at any one price in any one sector and saying, ‘That’s the one.’ We don’t target housing prices, for example,” Powell said. “Any price that contributed to ongoing inflation would matter. Any price that contributed to ongoing disinflation would matter too, but I wouldn’t single out housing as having a special role there.” But Gapen said the rollback of housing inflation could serve as an important signpost for the Fed as it looks to see a sustained trend of easing price increases. Philadelphia Fed President Patrick Harker, a nonvoter on the FOMC this year, on Tuesday singled out the “long-term stubbornness of shelter inflation.” He said multiple months of good data would convince him of one rate cut later this year.
