Weekly Market Insights
Inflation
CPI-U, % Change Year/Year
September 28, 2009
An outbreak of inflation is unlikely over the next 12 to 18 months because the economy is burdened by excess capacity in the labor market, factories, houses and commercial real estate. In fact, disinflation (slower price gains) and outright deflation (falling prices) are more likely in the near term, particularly for commercial real estate. The average effective rents for office and industrial space, which include concessions such as periods of free rent and above-standard tenant improvement allowances, have declined by 36 and 35 percent, respectively, from their recent peaks. The Moody’s/REAL Commercial Property Price Index, which measures prices based on repeat sales, has slipped 39 percent from its peak in October 2007. Non-residential construction costs have declined by 7.6 percent over the past 12 months according to the Bureau of Labor Statistics while the average price of a development site has plunged by nearly 60 percent since December 2007 as reported by Real Capital Analytics. Though a near-term bout of inflation is unlikely, inflation could crop up as the recovery gains momentum. Under such a scenario, credit demand in the private sector could begin to compete with borrowing by the Treasury Department, which needs to finance a national debt that is expected to more than double over the next 10 years to $17.5 trillion according to the Office of Management and Budget. Federal Reserve Governor Kevin Warsh, in a speech last Friday, recognized this threat and suggested that the Fed will need to aggressively raise interest rates at some point down the road to head off inflation. If the Fed were to adopt such a policy, it would translate into a weaker recovery in return for lower inflation over the next few years.
Robert Bach, Senior Vice President, Chief Economist, has 30 years of professional experience in real estate market research, consulting and city planning. His commentary on the real estate markets is provided here on a weekly basis.