US deflation fears have been fanned by a fall in annual core CPI inflation – excluding food and energy – to 0.9%, the lowest since 1966. The decline, however, from 2.4% when the recession started in December 2007 is entirely explained by the "shelter" component. Excluding shelter, core inflation was an annual 2.0% versus 1.9% in December 2007 – see chart.

Shelter has a 42% weight in the core CPI while 78% of the shelter component is accounted for by "owners' equivalent rent" (OER) – statisticians' estimate of what homeowners would pay if they rented their properties. OER inflation has fallen from an annual 2.8% in December 2007 to -0.2% by July. To repeat, no consumer actually pays OER.

OER inflation tends to follow house price inflation with a lag. The 12-month rate of change of the Case-Shiller 20-city house price index has recovered from a trough of -19% in January 2009 to 5% by May this year. OER has started rising recently, with a 0.7% annualised gain in the three months to July. Allowing for the normal lag, this recovery may be sustained over the remainder of 2010, putting upward pressure on core inflation.

The consensus interpretation is that US core inflation, unlike its UK counterpart, has been responsive to a large negative "output gap". The rise in the core ex. shelter measure since the beginning of the recession casts doubt on this view. Even in the US, it seems that the disinflationary impact of economic slack has been small and offset by other factors, including "QE", via its effects on the exchange rate and inflationary expectations.