The ECB’s concern: inflation would be much higher if housing is included in the CPI

Should housing in the Eurozone and Spain have more weight when calculating the CPI as is done, for example, in the US? What about inflation? The European Central Bank (ECB) is working together with Eurostat (the Brussels statistical agency) to give more weight to housing in the harmonized CPI (HICP) that is published every month. The latest results of these tests “they are a source of concern”, as recognized by the ECB itself: today housing would be adding fuel to the fire of an inflation that presents a high temperature.

House prices in the euro zone are rising at the fastest rate since 2007, in the midst of the housing bubble in much of the currency bloc. However, these data still pertain to the second quarter of 2021 and everything indicates that during the third and fourth quarters prices could have grown even faster. This trend, together with the rise in the usual costs that a homeowner faces, would be skyrocketing ‘the occupied housing price index’ that the European institutions propose to include in the HICP or at least begin to take into account when making their monetary and fiscal policy decisions.

This index would be weighted in the typical European consumer basket and would be accounted for as a service that the owners would pay of housing to have a roof where to shelter. The formula proposed by the ECB would be closely related to the evolution of property prices, as recognized by the central bank itself.

Right now, while rents are clearly weighted in the IPCA (with a weight of 7.47%), a good part of the housing expenses faced by owners could be underrepresented, despite the fact that millions of families opt for the they buy every year or already occupy a home that they own for which they may be paying a mortgage. The ECB’s own chief economist, Philip R. Lane explained in the middle of the central bank’s monetary strategy review that owning a home has a consumer element, since “every day you enjoy the services of living in your own home”.

More inflation in Europe

The ECB seems willing to change this and revealed this summer (in its monetary strategy review) that housing would begin to have a greater weight in inflation rates. While in the past this would have helped the euro zone to have inflation closer to 2%, today this could be one more headache for a central bank that maintains a very expansionary monetary policy together with high inflation, which has generated criticism in the countries that least tolerate the deviation above inflation (Germany, the Netherlands, the Baltics …).

Now that real estate is rising sharply, the inclusion of this indicator could be an aggravating factor. The minutes of the October ECB meeting recognized that “the growth in costs of owner-occupied housing had accelerated at a rate of 4.5% year-on-year in the second quarter of 2021, which is reason for concern, since this indicator would have contributed between 0.4 and 0.5 percentage points to inflation in the second quarter of the year according to an experimental HICP that includes these costs of home ownership “.

In the second quarter of 2021, inflation in the euro zone was still close to 2%, however having included housing would have meant exceeding the ECB’s target. Now that inflation is at 4.9% and house prices are rising at a higher rate, ‘imputed rents’ could easily drive the IPCA above 5%. In Spain, the CPI stood at 6.7%, according to the latest data from the INE.

Eric Dor, director of economic studies at the IESEG School of Management in Lille, pointed out in a paper on this issue that “the weight of the direct cost of housing in the harmonized consumer price index is limited to the part of the rents actually paid by tenants. The weight of these rents paid in the harmonized consumer price index is currently capped at 7.469% for the entire euro area. ”

This expert assures that, therefore, “the composition of the harmonized consumer price index underestimates the share of the cost of housing in the total household budget, as the home ownership rate in the euro area is 65.8%, according to Eurostat. The cost of owner-occupied housing depends primarily on housing prices (not rent). The purchase prices of new or existing houses have recently risen much faster than IPC or even its rental component, “warns this expert.

This economist concludes that depending on the weight (weighting) given to housing in the CPI and the type of index that can be used, inflation in the euro zone could have been between 0.25 and 0.66 points since 2019 Percentages higher than average (quarterly) with respect to what has been published.

This, today, could put pressure on the ECB itself, which in the face of higher inflation would be forced to act earlier and more forcefully. Although the occupied housing price index does not yet weigh in the IPCA, it is expected to be included in some way throughout 2022, so there are already analysts who have begun to launch their forecasts incorporating this variable.

Anatoli Annenkov, an economist at Societe Generale, warned after the December ECB meeting that in principle it is expected that “the first rate hike will come after 2022, (we expect it by the end of 2023) but clearly a lot can change in the next few years. next six to nine months, with a revision of the forecasts (or the inclusion of the costs of owner-occupied housing) that prospects for earlier tightening are increased. “

This expert explains that the labor market is recovering faster than expected, “therefore, it seems that the ECB could be beginning to believe that something stronger is happening in the labor market, something that will bring core inflation much closer to target. of inflation from the ECB as of next year. If to this is added the inclusion of the cost of the houses occupied by its owners, it is most likely that the forecasts of the ECB itself will be at the inflation target, if not above , which would require a faster adjustment. “

Why have they not yet been included in the IPCA?

This is a controversial issue, since the house fulfills a double function: offers a shelter and protection service (a service that is consumed and that is well represented in the IPC), as well as being an investment asset and savings vehicle, which should not have a place in the IPC basket, nor does it they have the stocks or the gold.

The cost of housing can be transferred to the CPI in two different ways and the ECB seems to be about to choose the one that the consensus of economists likes the least. On the one hand it can be calculated with what known as imputed rents, which would be a formula that would calculate the rent that homeowners should pay to live in it, using the market rental price.

However, the one the ECB wants to use is known as net acquisition approach 80% is made up of the cost of buying a home, that is, of the evolution of prices in the real estate market. The ECB believes that this is the formula that best reflects the cost of housing for families, while economists such as Zlotan Darvas believe that “This approach would involve including an investment asset in the price indicator to the consumer, which is clearly unjustified. The consumer price index should measure the cost of living, not the cost of investing in assets. It is not surprising that other investment assets, such as stocks, bonds, and mutual fund shares, are not included in consumer prices. “Using this method will make the IPCA more volatile and complicate the mission of central banking. , according to this expert.