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Federal Reserve officials won’t say it, but it appears that they’ve beaten back inflation about as far as they can, at least without risking a recession.
With rising housing costs blocking further progress, the Fed should start cutting interest rates ASAP.
There’s no guarantee, but cheaper borrowing costs could spur construction of new homes and apartments. The much-needed increase in supply would put downward pressure on home prices and rents.
The news: The central bank’s preferred price gauge was flat in April, the Commerce Department said on Friday. After a sharp slowdown last year, the inflation rate has been stuck.
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The numbers: The Personal Consumption Expenditures Index rose 2.7 percent from April of last year, matching the March increase. Excluding volatile food and energy costs, so-called core PCE was 2.8 percent, down just a few hundredths of a percentage point from the rate in March.
The Fed believes PCE, especially excluding food and energy, offers a clearer picture of underlying inflation trends than the better-known Consumer Price Index.
Why it matters: Core PCE has cooled from a post-pandemic peak of 5.6 percent in February 2022. But with the index all but stalled this year, the Fed has put cutting rates on hold.
Meanwhile consumers and businesses are grappling with the highest borrowing costs in more than two decades.
Central bank policy makers have said they won’t reduce interest rates until they’re confident inflation is once again moving consistently toward their 2 percent target.
The culprit: Rising shelter costs are making it hard to get inflation to the Fed’s bogey. Shelter expenses generated more than 30 percent of the increase in PCE inflation in April, according to an analysis by Eric Pachman, chief analytics officer at Bancreek Capital Advisors, a money management firm in Santa Monica, Calif.
PCE shelter costs are derived from monthly rents and an arcane calculation called imputed rent for owner-occupied housing. The latter is the government’s attempt to estimate what homeowners would have to pay if they rented their homes instead of owning them.
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No one actually pays the owner-occupied rent amount, yet the estimate accounts for about 12 percent of the PCE index. Along with rents, shelter made up about 15.5 percent of the overall PCE index in April, the second largest component after health care at 16.6 percent, Pachman’s data show. But shelter costs jumped by 5.6 percent over the past year, double the rate of health care, which explains its big impact on PCE.
Excluding shelter, overall PCE would have increased by 1.8 percent in April, below the Fed’s target, according to Pachman’s numbers. What’s more, PCE excluding shelter has been running at 2 percent or less since October.
What is the Fed waiting for? Policy makers say they need to see price gains cool for services other than housing that are running hot, including motor vehicle insurance and repairs, and investment services. They are also closely watching wage growth and whether the labor market continues to loosen up.
“Progress on inflation will very likely require lower growth in demand” from consumers and businesses, said Susan M. Collins, president of the Federal Reserve Bank of Boston, in a speech at MIT last month. “In this context, the role of monetary policy is to restrain demand” with high interest rates, she said.
In other words, choke the economy until spending dries up enough to return inflation to its pre-pandemic norms.
OK, but: The Fed is being ultra-cautious. Its reputation as an inflation fighter is on the line.
The European Central Bank has already started to roll back its rate hike. Using a measure called the Harmonized Index of Consumer Prices, inflation rates in Europe and the United States are about the same.
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Balancing act: The Fed is in a tough spot. Reduce rates too soon and inflation might reignite. Wait too long, and the so-called soft landing could turn into a recession.
But while the Fed waits for further improvement, the housing shortage only gets worse. There isn’t enough inventory of apartments and homes to meet even reduced demand. Developers say new projects that would increase supply are untenable at current borrowing rates.
Final thought: The data show that shelter costs specifically, not the rate of overall inflation, are the big problem.
It’s time to start cutting rates.
Larry Edelman can be reached at larry.edelman@globe.com.