Tighter monetary policy reduces rent inflation- SF Fed paper

Tighter monetary policy reduces rent inflation- SF Fed paper

(Reuters) – A tightening of monetary policy by the Federal Reserve results in a reduction in rent inflation albeit at a slow pace, according to a San Francisco Fed analysis released on Monday.

The U.S. central bank is closely scrutinizing the impact of its actions after it raised interest rates last year by more than 400 basis points, the fastest pace since the early 1980s, in order to bring down high inflation that had spread across the economy.

When the Fed tightens policy equivalent to a 1 percentage point increase in its benchmark interest rate, that can lower the pace of rental inflation by up to 3.2 percentage points over a 2-1/2 year time frame, the San Francisco Fed researchers wrote.

Rents have surged over the past two years and make up an important component of the Personal Consumption Expenditures (PCE) price index, the Feds preferred inflation measure, but central bank officials have indicated they expect a recent moderation in the pace of price increases in that sector to continue this year.

According to the paper, the policy tightening translates to a maximum reduction in headline PCE inflation of about 0.5 percentage point over the same time horizon.

Annual rent inflation measured using the PCE housing price index rose from 2% in early 2021 to 7.7% by December 2022, the highest level since 1986. Housing expenditures represent about 15% of total PCE.

“We present evidence that monetary policy tightening is effective for reducing rent inflation, although the full impact takes time to materialize,” San Francisco Fed vice president of international research Zheng Liu and research associate Mollie Pepper wrote in their paper.

House prices are more sensitive than rental prices to changes in financial conditions, because home purchases typically require longer-term mortgage financing. But monetary policy can affect both house prices and rents by cooling housing demand, the paper said.

The Fed‘s main interest rate is currently in a 4.50%-4.75% range. Overall PCE inflation is still running at 5.0% annually, far above the Fed’s 2% target rate although down off its peak.

“Although average rents are slow to respond to policy changes, growth of asking rents on new leases has started to slow following recent monetary policy tightening,” the researchers continued. “Our finding suggests that this tightening will gradually bring rent inflation down over time, thereby helping to reduce overall inflation.”

In calculating their findings, the duo drew on the effectiveness of monetary policy tightening for reducing rent inflation from 1988 to 2019 with the impact based on housing costs share in total PCE.

(Reporting by Lindsay Dunsmuir; Editing by Andrea Ricci)