A Trendy Corner of Madrid Lays Bare Flaw in Europe Inflation

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In the trendy Malasaña neighborhood of Madrid, Ramon G. Del Pomar’s rent tripled to 3,500 euros ($3,900) per month when his contract came up for renewal. It was the kind of bumper increase that’s become a scourge of up-and-coming areas across Spain in recent years -- all while official inflation averages about 1%.

“When I hear 1%, I laugh,” the 69-year-old Del Pomar said in an interview. “The figure must be false, because many, many people now pay more than half their income just for an apartment.”

The apparent disconnect between official statistics and real-world costs hints at a problem at the heart of European monetary policy: Despite the best efforts of the central bank and quantitative easing totaling 2.6 trillion euros, inflation remains stubbornly low. If the experiences of people like Del Pomar are anything to go by, gauges of consumer price growth could be undershooting because they’re missing important inputs -- meaning European Central Bank policy is calibrated incorrectly.

With a new era of stimulus beginning and critics railing against central banks for their impotence, the question of how to calculate inflation is a crucial part of the debate. And the accuracy of euro-area housing statistics has long been a point of contention.

S&P Global Ratings said this week the ECB should include homeowners’ costs in housing calculations. That would likely take it down another policy path, toward financial stability and away from easing, according to S&P economist Sylvain Broyer.

“If the ECB had been targeting this higher inflation measure, they might have refrained from restarting QE in September,” Broyer said in an interview.

In Europe there are no private figures on housing costs for government statisticians to use as a comparison, and somehow they have become minimized in inflation readings in Spain and many developed countries. Home purchase prices, which tend to lead or track rents, are climbing about 5% a year in Spain and 4% in the euro zone overall.

S&P reckons that if the ECB took into account prices of owner-occupied dwellings, its CPI measure would increase by 0.3 percentage points and fuel a “sustainable rise” in the central bank’s inflation expectations.

Spain is trying to improve the way it takes the temperature of the housing market and will unveil a new index next month. Most rental contracts for new apartments entering the market are excluded from inflation, according to a Bank of Spain report. Asking prices for rent jumped 50% nationwide in the previous 5 1/2 years, the research showed. Government statisticians figured housing costs rose barely 3% in the period.

The nation’s consumer-price reading and the bond market are unlikely to be rocked just yet, however. Government and central bank officials wouldn’t speculate on whether the new index might reflect more robust price growth, or if it will be used in CPI, which currently puts annual consumer inflation at just 0.2%.

A spokesperson for Eurostat, which compiles price data, said that while revising the inflation index to capture more housing costs was considered and rejected in 2018, “research will continue.” An ECB spokeswoman declined to comment.

Eurostat calculations assume consumers spend more on water, power and gas than they do on their rent. In Spain’s case, it implies a household with 2,000 euros a month in disposable income pays only 60 euros a month in rent.

“How can 60 euros a month cover the cost of housing?” said Boris Cournède, a veteran economist at the Organization of Economic Development who wrote a 2005 research paper studying the impact of excluding housing from CPI calculations. “A campground fee would be more than that.”

By contrast, housing is weighted at about 33% of the U.S. spending basket.

Spain’s new index was not meant for calculating inflation. It was demanded by a 2019 law as a tool for curbing rental spikes that have driven tenants from neighborhoods where they’ve lived for decades -- which is exactly what happened to Del Pomar.

Like tens of millions of Europeans, housing is his biggest monthly expense. Yet it is minimized in inflation statistics, the undershooting of which have implications for everything from bond pricing and wage increases to pension payments across the $14 trillion euro-area economy.

“There’s definitely a big part of housing consumption that’s not in consumer prices,” Cournède said.

--With assistance from Ainhoa Goyeneche, Paul Gordon and Paul Dobson.

To contact the reporter on this story: Todd White in Madrid at twhite2@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Gutscher

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