How the Euro area and ECB mislead people over the inflation numbers

This week has brought something of a confession from the European Central Bank. It relates to something that they and the Euro area establishment have kept out of their official inflation measure for 25 years now. It is owner occupied housing costs and they matter a lot which from time to time they confess as I recall a speech from Chief Economist Lane several years ago saying that they were up to a third of peoples spending. Since then the ECB has set out on a policy of making these costs higher via its interest-rate rises.

If we look at its mortgage interest-rate measure we are told this.

new loans to households for house purchase decreased by 4 basis points to 3.84%, driven by interest rate effect

The crucial point here is the level and as these are for February the recent rises in bond yields will mean we are now back to circa 4% ( the peak has been 3.97%). That compares with a long period where they have been below 1.5% and it only went above that level in April 2022. So in terms of the cost of living those paying a mortgage in the Euro area have seen an increase of 2.5% in round numbers which is a lot.

ECB Analysis

A couple of ECB economists have taken a look at the real world impact of this and unsurprisingly start with this.

In recent quarters, euro area households have been faced with higher housing costs, including mortgage costs.

You do not need a Phd to discover that! But then they start to pit some numbers on the actual impact.

Chart A, panel a), shows the dynamics of the overall monthly housing-related burden for outright owners, renters and mortgagors. In January 2024 households were paying an average of €765 per month in total housing-related costs, including utilities, home maintenance and rent or mortgage costs.

As you can see this is a major factor in people’s budgets and you should not ignore a large component of it. But then we get their view on hos much inflation in this area has been understated during the recent inflationary surge.

Over the period from July 2022 – the beginning of the interest rate hiking cycle – to January 2024, the average housing costs reported in the Consumer Expectations Survey rose cumulatively by around 10.2%, compared with a cumulative rise in the Harmonised Index of Consumer Prices (HICP) of 5.5%.

As you can see this is a big deal and later in the piece they confirm this as they get around to how much of an issue this is for household budgets.

Housing costs take up around 20% of disposable income for outright owners, 40% for renters and 35% for mortgagors.

If we were discussing any other area there would be screams for its inclusion. But because it has always been excluded then we are in the arena of the military dictum that one of the best ways of hiding something is to put it in plain sight. I think that modern culture leading to shorter attention spans and the decline of journalism have also contributed to the lack of criticism and analysis.

National Variations

Our 2 economists sort of get there.

For mortgagors in particular, the higher costs would seem to be driven by the upper end of the distribution, with the cost for the lower end remaining relatively constant.

In plain English some with fixed-rate mortgages will not have been affected, but those with variable-rate ones will have been severely affected. That brings me to something they will have missed as the situation in Portugal became so bad that the government changed the rules to allow some mortgage payments to be deferred.

A set of measures is in place until 31 December 2023 to mitigate the effects of the rise in interest rates on variable rate loans for the purchase or construction of permanent residential property with an outstanding value of €300,000 or less. ( Bank of Portugal)

There were other reliefs for larger mortgages but the point was that the rise in mortgage costs was so high in Portugal that the rules were changed to avoid an economic crisis. Actually we do see that in this report because it is for numbers up to January this year and Portugal has one of the lowest housing costs quoted at 600 Euros a month. That would mislead the unwary who do not realise that the numbers have been fudged! Or to be more specific that poor battered can has just been kicked again.

Anyway the report puts it like this..

With regard to individual euro area countries, Chart A, panel c), shows that there is significant cross-country heterogeneity in housing costs and that the difference between costs excluding mortgage payments and those including such payments is substantial, especially for countries such as Italy and Spain that tend to have a higher proportion of adjustable-rate mortgages.

Unfortunately we just get a chart rather than detailed numbers but their calculations are that Spain has monthly housing costs of 750 Euro a month if you include mortgages and 400 if you do not and for Italy it is just under 800 Euros a month with and 550 without. Ireland has the highest housing costs at 1200 Euros a month with mortgages and 900 without them.

Pinocchio Time

Our 2 economists must suddenly have realised the consequences of their work and feared being sent to the ECB cellar where the cake trolley with its espressos and croissants never arrives.

The housing cost ratio, defined as total housing costs divided by disposable income, has remained unchanged overall since the beginning of 2022.

So disposable income has magically risen by the same amount? What a happy coincidence. Funny how the wages figures have somehow missed this as we have been recording quite substantial falls in real wages in the Euro area and remember that is before you add mortgage costs to the inflation numbers.

Also this bit is rather inconvenient for the “remained unchanged” claim.

More households, and in particular lower-income households, have indicated in recent months that they expect to make late payments of their rent or mortgage and/or their utilities. Given the present and future effects of both increased interest rates and loss of purchasing power owing to inflation, the ability of households to meet their housing-related costs and mortgage payments is a source of concern, especially for lower-income households.

How does “remained unchanged” morph into “loss of purchasing power”?

“For, you see, so many out-of-the-way things had happened lately, that Alice had begun to think that very few things indeed were really impossible.” ( Lewis Carroll)

Comment

As you have seen the exclusion of owner-occupied housing costs means that the cost of living in the Euro area has risen by much more than what the official inflation rate has told us. In technical terms it is the difference between a macroeconomic measure and a cost of living one. Just because a central bank should ignore mortgage costs in its measure as otherwise it ends up rather chasing its tail, does not mean people are not facing a higher cost of living. Rather curiously the Bank of Canada either forgot or does not realise this.

But back to the central point the failure to include housing costs in a proper manner means that the cost of living in the Euro area has been severely understated. Today I have looked at the rise in mortgage costs over the past couple of years. But before that there were the rises in house prices driven by an official interest-rate of -0.5% and all the QE bond buying.