ECB Inquiry May Push for Overhaul of Inflation as We Know It

(Bloomberg) --

The European Central Bank’s decision to review how it measures inflation is likely to raise pressure for a much-needed overhaul of the gauge that guided officials to impose negative interest rates on the region.

Including home-acquisition costs -- not just rents -- in the euro zone’s inflation gauge would likely boost the index through reflecting residents’ full housing costs. The move would follow similar moves by some of the ECB’s peers, including the U.S. Federal Reserve.

The idea has been around for years -- Europe already has an experimental index -- but getting it implemented might require political maneuvering. A measure that shows higher inflation could push up bond yields, irritating governments in the most-indebted economies that worry about financing and pension costs. A potential revamp might roughly triple the weighting of housing in the current benchmark.

“It’s really high time the European authorities advanced on this,” said Boris Cournède, a veteran Organization of Economic Development economist whose 2005 research on the subject was a milestone. “Housing is weighted so low -- it’s a statistical artifact.”

ECB President Christine Lagarde said on Thursday that the way consumer prices incorporate housing costs would be part of her larger strategic review, which will go beyond questions of targeting inflation to whether they’re actually defining it properly.

The decision turns a spotlight on the pilot project devised by the European Union’s statistics agency, Eurostat. Its experimental index incorporating owner-occupied housing shows the average cost of shelter across the region jumped 17% in the past five years, dwarfing the 1.3% rise in housing -- limited only to rents -- currently in its Harmonized Index of Consumer Prices, weighted for gross domestic product.

Official inflation currently reflects no homeowner expenses even though they’re increasingly the biggest single cost for Europe’s middle class.

“Acknowledging that consumer inflation is actually higher would take pressure off the central bank to provided additional easing,” said Richard McGuire, head of rates strategy in London for Rabobank.

It’s always possible the ECB would simply opt for a parallel, informational gauge instead, as the U.K. has done. The ECB and the European Commission haven’t embraced the idea over the years, saying it’s difficult to calculate in a timely way.

The current weighting of housing is about 6.5%, meaning that is statisticians’ assumption of its burden in the average consumer budget.

“If we believe that there is a clear miscalculation between what is there -- which is roughly 6% of the budget, if I recall -- and what is the perception, we need to understand why,” Lagarde said. The ECB might then “need to pass that on to Eurostat, and have Eurostat do further, additional work.”

Peter Schaffrik, global macro strategist at RBC Capital Markets in London, wrote Friday in a note that while “an abrupt change” in the inflation measure this year is unlikely, “it does appear that the governing council is learning towards a measure of inflation that accounts for the cost of OOH as more appropriate,” referring to owner-occupied housing.

Sylvain Broyer, an S&P economist in Frankfurt, points out that three central banks whose inflation targets do capture owner-occupant costs -- those in the U.S., Sweden and Norway -- each were able to hike interest rates at least once in the last upturn. Meanwhile the ECB is flushing 20 billion euros ($22 billion) a month of fresh funds into the Eurosystem to kindle prices.

Even if Lagarde’s review does result in a formal call for change, she was at pains on Thursday to stress that a new inflation measure is still some way off.

“I’m not suggesting it’s going to be resolved in one year,” she said.

--With assistance from Ainhoa Goyeneche.

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

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Craig Stirling, Jana Randow

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