Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / Why Central Banks Are Watching Rent Inflation
Transcript
- Lucas: So, we're in mid-2026, and the inflation story has basically split into two worlds. Goods prices? Mostly flat or falling. Energy? Volatile but down from the peaks. Services? Sticky. But one category above all others is keeping central bankers up at night, and it's the one you can't avoid paying every single month: rent. Luna: Shelter inflation. The beast that refused to die through 2023 and 2024. Lucas: Exactly. And it's still a problem. If you look at the latest CPI release for June, headline inflation is running around 3.1 percent year-over-year. Strip out shelter? You're looking at maybe 1.8. Shelter alone is contributing about 1.3 percentage points to that headline number. So the question is: why hasn't rent inflation come down faster, and what does that mean for the Fed's next move? Luna: Right, and to understand that, we need to look at how rent is actually measured, because it's not like checking the price of a gallon of milk. Lucas: No, it's much weirder. The Bureau of Labor Statistics uses two main measures: rent of primary residence, which is what you'd think — actual rents paid by tenants. And then Owner's Equivalent Rent, or OER, which is this hypothetical: what homeowners would pay to rent their own home. OER makes up about 24 percent of the total CPI basket. Combined, shelter is roughly one-third of the index. Luna: And that's why when shelter is sticky, the whole CPI number stays high. Lucas: Exactly. But here's the crucial thing: the CPI rent measures are based on surveys of renters, and they're slow to reflect what's happening in the market. When market rents surged in 2021 and 2022 — up 15, 20 percent in some cities — the CPI rent index barely budged at first. It took about 12 to 18 months for that surge to fully feed into the official numbers. Luna: So by the time CPI showed peak shelter inflation in early 2023, market rents were already starting to cool. Lucas: Exactly. And that created this forecasting headache. The Fed was looking at backward-looking data. The markets were looking at real-time apartment list data from Zillow or Apartment List, which showed rent growth slowing sharply. But the CPI kept printing high shelter inflation because it was still catching up. Luna: And that's partly why the Fed kept raising rates longer than some people expected. Lucas: I think that's a fair read. Now, as of July 2026, the dynamic has changed. Market rent growth has been moderating for about two years. Some markets are actually seeing rents decline year-over-year — Austin, Phoenix, parts of San Francisco. But CPI shelter inflation is still running at about 4.3 percent year-over-year. That's down from the peak of 8.2 percent in early 2023, but it's still well above the Fed's overall 2 percent target. Luna: So there's still a gap. The question is, how much more shelter disinflation is baked in? And when does it actually show up? Lucas: That's the trillion-dollar question. The BLS has started publishing a supplemental index — the New Tenants Rent Index — which captures rents for people who actually moved recently. That index has been showing much lower inflation, around 2 percent or so. But it's not the official measure. The official measure includes all renters, including those who have been in place for years and may not have seen a rent increase. Luna: And that's the structural lag. Because if you're a renter who hasn't moved, your rent might only go up 3 percent a year, while a new tenant in the same building might pay 10 percent more. The CPI averages those. Lucas: Right. So the official CPI rent index is a mixture of new and existing leases. And since most people don't move every year, the existing lease component dampens the volatility. That's actually a feature — it makes CPI less jumpy. But in a period of rapid change, it introduces a long tail. Luna: So what does this mean for monetary policy here in mid-2026? The Fed has held rates steady since last September. They've been waiting for more evidence that inflation is sustainably heading to 2 percent. And shelter is the big piece that hasn't fully cooperated. Lucas: Yeah. Chair Powell has mentioned shelter specifically in the last two press conferences. At the June FOMC meeting, he said, 'We are seeing progress on shelter, but it is coming more slowly than we anticipated.' And the dot plot showed only one rate cut this year, down from three projected in March. A big part of that is the shelter stubbornness. Luna: But if the new tenants rent index is already at 2 percent, doesn't that mean the official measure will eventually follow? It's just a matter of time. Lucas: That's the standard argument, and I think it's largely correct. Most forecasters expect shelter inflation to gradually decline to around 3 percent by the end of 2026, and then to about 2.5 percent by mid-2027. But the Fed has been burned by predictions before. In 2023, everyone thought shelter would cool faster. The lag was longer than expected. Luna: Because of the mix of new and existing leases, and because landlords were slower to cut rents than they were to raise them. Lucas: Exactly. And there's another factor now: the multifamily construction boom of 2022 and 2023 is still delivering new supply. In markets like Austin, that's putting downward pressure on rents. But in other markets, especially in the Northeast, supply constraints are keeping rents elevated. So the national average hides a lot of regional variation. Luna: And central banks outside the US are dealing with similar issues. The European Central Bank has its own version, though rent makes up a smaller share of their CPI — around 10 percent for the euro area, because more people own homes. But OER is not used in the same way. Lucas: Right, the ECB uses actual rents and also includes imputed rents in their broader inflation measures, but it's not as dominant. However, in countries like Germany, where the rental market is huge, rent inflation has been running at 4 to 5 percent. The Bank of England, interestingly, doesn't include OER in their CPI at all — they use a measure called CPIH, which includes owner-occupier housing costs. And they've been experimenting with using private-sector data from companies like Rightmove to get more timely reads on rent. Luna: So there's a data innovation angle too. The Fed is also looking at alternative data. The New York Fed has a research group that tracks online apartment listings. Lucas: Yeah, and that's actually been pretty informative. Their researchers have shown that the lag between market rent growth and CPI rent growth has been fairly stable at around 12 months. So if you look at the Zillow Observed Rent Index, which peaked in early 2022 and then flattened out, you can predict that CPI shelter inflation would peak about a year later and then slowly decline. That pattern has held. Luna: But if that's the case, then the continued high shelter inflation we're seeing now must be the echo of the market rent increases from early 2025? Or is it something else? Lucas: It's partly that, but there's also been a repricing in certain segments. Multifamily rents have been relatively flat, but single-family rental homes — think companies like Invitation Homes — have continued to see strong rent growth because demand for single-family rentals remains high. That segment is not as well captured in the CPI because the BLS survey includes a mix of apartment and single-family units. Luna: So the composition matters. And the Fed has to look at all these layers. Lucas: Right. And I think the key takeaway for listeners is this: when you hear that inflation is still above target, ask yourself which components are driving it. Right now, it's shelter that is the primary stickiness. Goods inflation is mostly dead. Services inflation ex-shelter is running around 3.5 percent, which is also high but trending down. Shelter is the puzzle. Luna: And if shelter eventually normalizes, the case for rate cuts becomes much stronger. If not, we might be stuck at these levels for a while. Lucas: Exactly. And on that note, if this kind of breakdown is useful for you — walking through the mechanics of what's actually driving the data — that's exactly what we try to do here. And the way this show stays ad-free, without any sponsors, is through listener support. So if you got something out of today, you can find us at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash f-e-x-i-n-g-o. Luna: Yeah, and honestly, even a small contribution helps keep these episodes coming. We really appreciate the listeners who chip in. Lucas: Absolutely. So, circling back to the data: one thing I'm watching closely is the BLS's quarterly update to the rent survey sample. They refresh the sample every year, and sometimes that can cause revisions. If the new sample includes more units from the recent construction boom, it could pull the rent index down faster. Luna: That's a good point. And the July CPI release later this month will be the first to incorporate the new weights for 2026. That could be a big moment. Lucas: It could. So stay tuned. But for now, the bottom line is: rent inflation is the last mile of the inflation fight, and it's going to be a slow mile. Thanks for listening. Luna: Thanks, everyone. We'll be back tomorrow with another episode.