Inflation Accelerated in January

Inflation edged up to a six-month high in January and showed little progress from a year ago. The persistent inflation rate indicates the last mile to the Fed’s 2% target continues to be challenging and is consistent with the Fed’s cautious stance amid solid economic growth and growing uncertainty. While core inflation remained stubborn due to elevated shelter and other service costs, housing costs showed signs of cooling – the year-over-year change in the shelter index remained below 5% for a fifth straight month and posted its lowest annual gain since January 2022, suggesting a continued moderation in housing inflation.

While the Fed’s interest rate cuts could help ease some pressure on the housing market, its ability to address rising housing costs is limited, as these increases are driven by a lack of affordable supply and increasing development costs. In fact, tight monetary policy hurts housing supply because it increases the cost of AD&C financing. This can be seen on the graph below, as shelter costs continue to rise at an elevated pace despite Fed policy tightening. Additional housing supply is the primary solution to tame housing inflation.

Furthermore, the election result has put inflation back in the spotlight and added additional upside and downside risks to the economic outlook. Proposed tax cuts and tariffs could increase inflationary pressures, suggesting a more gradual easing cycle with a slightly higher terminal federal funds rate. However, economic growth could also be higher with lower regulatory burdens. Given the housing market’s sensitivity to interest rates, a higher inflation path could extend the affordability crisis and constrain housing supply as builders continue to grapple with lingering supply chain challenges.

During the past twelve months, on a non-seasonally adjusted basis, the Consumer Price Index rose by 3.0% in January, according to the Bureau of Labor Statistics’ report. This followed a 2.9% year-over-year increase in December. Excluding the volatile food and energy components, the “core” CPI increased by 3.3% over the past twelve months, following a 3.2% increase in December. The “core” CPI has held near 3.3% since May 2024. A large portion of the “core” CPI is the housing shelter index, which increased 4.4% over the year, following a 4.6% increase in December.  Meanwhile, the component index of food rose by 2.5%, and the energy component index increased by 1.0%.

On a monthly basis, the CPI rose by 0.5% in January (seasonally-adjusted), after a 0.4% increase in December. The “core” CPI increased by 0.4% in January, the highest monthly gain since March 2024.

The price index for a broad set of energy sources rose by 1.1% in January, with increases in gasoline (+1.8%), fuel oil (+6.2%), and natural gas (+1.8%), while the electricity index remained flat. Meanwhile, the food index rose 0.4%, after a 0.3% increase in December. The index for food away from home increased by 0.2% and the index for food at home rose by 0.5%.

The index for shelter (+0.4%) was the largest contributor to the monthly increase in all items index, accounting for nearly 30% of the total increase. Other top contributors that rose in January include indexes for motor vehicle insurance (+2.0%), recreation (+1.0%), as well as used cars and trucks, (+2.2%). Meanwhile, the index for apparel (-1.4%), personal care (-0.1%) and household furnishings (-0.2%) and operations were among the few major indexes that decreased over the month.

The index for shelter makes up more than 40% of the “core” CPI, rose by 0.4% in January, following an increase of 0.3% in December. Both indexes for owners’ equivalent rent (OER) and rent of primary residence (RPR) increased by 0.3% over the month. Despite the moderation, shelter costs remained the largest contributors to headline inflation. 

NAHB constructs a “real” rent index to indicate whether inflation in rents is faster or slower than core inflation. It provides insight into the supply and demand conditions for rental housing. When inflation in rents is rising faster than core inflation, the real rent index rises and vice versa. The real rent index is calculated by dividing the price index for rent by the core CPI (to exclude the volatile food and energy components).

In January, the Real Rent Index fell by 0.1%. This marks the first time since December 2021 that rental prices grew slowly than core inflation.