Housing is still propping up inflation more than the Federal Reserve wants.
The shelter component of the Consumer Price Index (CPI) — one of the government’s main gauges of inflation — rose 0.6% over the last month and 7.1% on a yearly basis in September. It was also the largest contributor to the monthly increase in inflation for all items, accounting for more than half of the increase.
That underscores how much of an obstacle housing has been in the Federal Reserve’s fight to bring down inflation, but the gains in the shelter index could fade as more recent housing data makes it into the overall inflation index.
"It was larger than expected," EY chief economist Gregory Daco said about the shelter index increase. "It's a category that I would expect and I still expect to show more disinflationary momentum."
"I would anticipate that in October, November, December… and the first quarter of next year, we're going to see a more pronounced pass through of the real-time data," he said.
Headline inflation rose 3.7% in the 12 months through September, steady from 3.7% logged in August, and a 0.4% gain over the previous month, the Bureau of Labor Statistics reported Thursday.
The pace of inflation is still well above the Federal Reserve’s stated long-term target of 2%, supporting the central bank’s "higher for longer" stance on interest rates.
Read more: What the Fed rate-hike pause means for bank accounts, CDs, loans, and credit cards
One way for inflation to come down is for a meaningful change in the shelter index, which makes up a third of the overall inflation index.
That measure includes the cost of housing for both renters and homeowners as well as lodging away from home and tenants’ and household insurance.
Owner's equivalent rent, or OER, and rent are by far the most significant inputs to the shelter index. OER is the hypothetical rent you’d pay for your own property and indirectly takes into account home price growth.
OER makes up 74% of the shelter index, or contributes 24.42% to overall CPI, while rent accounts for a smaller portion of both — 22% of the shelter index and 7.5% of CPI. In September, OER recorded a monthly gain of 0.6%, while rent prices marked a 0.5% gain on a seasonally adjusted basis.
The rent component is a notorious lagging indicator, not reflecting real-time data. September’s reading has yet to capture the steep deceleration in rent growth that started in the middle of last year.
For instance, rents in September nearly flattened out, rising a muted 0.1% compared to the same period last year, according to RealPage. For perspective, the annual growth rate stood at 9% a year ago.
Daco called the increase in the rent portion a "temporary rebound or reacceleration."
"I would not necessarily believe that this is going to remain, that we're going to see these 0.5% increases going forward," he said. "I would anticipate that we're going to move lower…into the latter part of this year."
Separately, home prices — which indirectly affect OER — remain resilient, rebounding from a pullback last year. In fact, the S&P CoreLogic Case-Shiller’s national home price index increased 0.6% month over month in July and 1% over the last 12 months, reaching a new high.
Read more: How to buy a house in 2023
While Case-Shiller doesn’t report August figures until later this month, other home price gauges show continued strength. Home prices registered yet another record high in August, according to Intercontinental Exchange's Black Knight, a mortgage data provider, marking the fourth straight month of new peaks.
"When you look at the owner's equivalent rent, which largely reflects home prices, you're seeing more persistence," Daco said. "The disinflationary momentum in terms of home prices has been less than initially estimated."
That could soon change. Those home price increases occurred before mortgage rates soared toward 8%, remaining at the highest level in 23 years in recent weeks. That’s had a recent chilling effect on buyers, coinciding with the typical seasonal slowdown in activity in the fall.
"Closed sales from August would have typically gone under contract in July when mortgage rates were 40-50 basis points lower than today," Andy Walden, vice president of enterprise research at Intercontinental Exchange, said in a statement. "As it stands, home affordability hit yet another 38-year low in September by way of spiking rates and prices, both of which could still serve to cool price gains as we move toward the end of the year."
Goldman Sachs housing economists predict home prices will fall by 1.3% through the last five months of the year, which could help curb shelter inflation and bring the Fed closer to its ultimate goal.
"So I'm actually encouraged, paradoxically, by the fact that a big part of the increase in core inflation was driven by shelter," Daco said, "because I expect that category will show more disinflationary momentum in the coming months given what we've seen in real time."
Read more inflation coverage:
Inflation: Consumer prices rose 3.7% over last year in September, matching August's increase
Stock open flat as CPI inflation holds steady: Stock market news today
Gas price increases eased but still 'major contributor' to September inflation print
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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.