Why Citi Analysts Predict Shelter Inflation May Experience Volatility in the Coming Months

US consumer prices increased by 0.2% month-on-month in August, consistent with the rate observed in July. However, the core consumer price index saw a slight uptick, indicating some persistence in inflationary trends despite a general easing of pressures.

The monthly increase in the headline consumer price index aligned with economists’ forecasts, and the annual inflation rate slowed to 2.5% from 2.9% in the previous month.

In contrast, core consumer prices, which exclude volatile categories such as food and energy, rose by 0.3% month-on-month, exceeding expectations of a 0.2% increase. On a year-over-year basis, core inflation remained steady at 3.2%, consistent with estimates and matching July’s figures.

Analysts at Citi highlighted that a significant portion of the core inflation’s strength was due to a surprisingly strong rise in shelter costs. Specifically, there was a 0.5% increase in the index for owners’ equivalent rent, up from 0.4% in July.

Owners’ equivalent rent is an estimate of what homeowners would pay to rent their own residences. This measure is intended to reflect fluctuations in real estate market values; however, its reliability has been questioned by some economists.

Citi’s analysts expressed surprise at the acceleration in owners’ equivalent rent but noted that they anticipate increased volatility in this measure in the near future, with expectations of fluctuating readings in the coming months averaging between 0.2% and 0.3%.

They further pointed out that the lower weight of shelter costs in the core personal consumption expenditures (PCE) price index, combined with “softer medical” expenses, is likely to result in a more subdued measure compared to the consumer price index (CPI). The underlying PCE results, which the Federal Reserve closely monitors as an inflation benchmark, are set to be released next Friday.

This forthcoming PCE data will be one of the first inflation indicators available to the Federal Reserve after it implemented a significant interest rate cut of 50 basis points on Wednesday.

Alongside this cut, an updated projection from Fed officials indicated that the benchmark federal funds rate is expected to drop to a range of 4.25% to 4.5% by the end of 2024. This outlook implies the possibility of another substantial half-point cut or two smaller quarter-point reductions during the remaining Fed meetings of the year.

At a press conference after the announcement, Fed Chair Jerome Powell eased recession concerns, emphasizing the overall decline in price increases and a “solid” labor market.

“The US economy is in a good place, and our decision today is designed to maintain that stability,” Powell stated.