This Week’s Developments in the US Economy

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Why are Eurozone inflation readings coming in lower than those of the US?

After an unexpectedly warm US CPI print this week, concerns that the decrease in inflation may have stalled are only reinforced by the progress made in the Eurozone. However, a core difference between the two inflation readings is shelter—the US has experienced high rent growth, measured on a lagged basis, and the Eurozone has not seen significant rent growth over the past two decades (see accompanying visual). While both the US and the Eurozone track price growth in their respective economic regions, there are nuances in how they measure inflation that have contributed to the current divergence in inflation figures across the regions. Last year, the Eurozone posted a higher peak than the US in headline inflation, yet current headline inflation in the Eurozone is 110-basis points lower compared to the US.

This does not necessarily imply that the European Central Bank (“ECB”) is winning the war on inflation before the Fed, but instead it speaks to some of those nuances in the US and Eurozone inflation measures. One key difference can be found in each methodology of housing inflation. Not only has the Eurozone seen slower rent growth than the US, but even had the region seen the same rent growth patterns as the US had over the past few years, it would still have a lesser impact on overall inflation in the Eurozone due to a lower index weight and the lack of lagged readings.

Methodological Nuances in the Housing Inflation Component

In March, the headline Harmonized Index of Consumer Prices (“HICP”) in the Eurozone fell from 2.6% to 2.4%, and core inflation decreased from 3.1% to 2.9%. The figures were below consensus, bolstering the case for a rate cut in the Euro Area this summer. In comparison, the figures were also lower than the March US CPI readings, where headline rose from 3.2% to 3.5% and core remained at 3.8%.

Within the current US headline CPI reading, shelter remains one of the largest contributors with 5.7% year-over-year growth and an assigned weight of 36.2%. In contrast, the housing component in the Eurozone holds less than half of that weight at 14.7% and has been disinflationary for the past seven months. The discrepancy in housing inflation numbers across the two regions can, among other methodological variations, partially be attributed to the volatile inflation readings from electricity, gas, and other fuels being grouped with the Eurozone's housing category, which differs from the approach used in the US.

Another notable difference in the shelter inflation measurement across the two regions is the exclusion of owner-occupied housing in the Eurozone. In the US owner-occupied housing is measured as Owners’ Equivalent Rent (“OER”) (Link to our piece on March 14?) and carries significant weight within headline CPI, amounting to 26.8%. This exclusion in the Eurozone helps prevent a hypothetical transaction (such as the US OER) from overinflating HICP readings. Further, most Eurozone countries collect rent data monthly, resulting in a shorter time lag between real-time rent growth and rent inflation figures compared to the US, where rent data is collected twice annually every six months for a sampled unit.

Vast Differences in US and Eurozone Rent Growth
According to the ECB, rent growth has contributed an average of only 0.1 percentage points to overall inflation since 1999. This is because rents have seen arguably modest growth in recent years when compared to the US and account for less than 6% of Eurozone HICP. In comparison, year-over-year US rent inflation reached 8.9% last year, while the highest rent inflation figure in Eurozone was less than a third of that at 2.8%.

Unlike in the US, the Eurozone shelter component is not currently driving overall inflation. However, rent inflation in the Eurozone has accelerated over the last few quarters, largely as a consequence of limited housing supply – a trend which might continue considering the -17.7% year-over-year drop in permits issued for residential buildings during 2023 in the Eurozone. While we have observed a softening of rent growth in the US amid an elevated supply environment in 2024, we anticipate a similar pattern of lower supply in the US in the near future.