CPI Drops, Does it Understate Deflation?

CPI increased by 0.1% month over month: consensus estimate was an increase of 0.3%. The year over year drop came in at 1.0%, the largest annual decrease in quite some time. Please note: both figures are seasonally adjusted. The media is reporting a 1.3% year over year drop, this is not seasonally adjusted.

Fingers are pointing to the drop in energy prices as the main cause for the falling CPI. This is indeed a major cause. Energy costs impact consumer prices directly (home heating/cooling, gasoline) and indirectly (food prices, apparel, etc.). However, the largest component of the CPI is an item called Owner's equivalent rent of primary residence (OER). OER's weight is 24.4% of the index. From the BLS:

Rental equivalence. This approach measures the change in the price of the shelter services provided by owner-occupied housing. Rental equivalence measures the change in the implicit rent, which is the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market. Clearly, the rental value of owned homes is not an easily determined dollar amount, and Housing survey analysts must spend considerable time and effort in estimating this value.

When initially introduced, the rental equivalence index’s monthly movement was calculated by reweighting the rent sample to represent owner-occupied units. Starting with the CPI for January 1987, the rental equivalence index movement was based on changes in the implicit rents of a sample of owner-occupied units. As part of the 1987 revision, BLS drew a new housing sample to replace the old rent sample. The new sample had both owner- and renter-occupied housing units.



As the above graph illustrates, this component has been moving higher as home prices have been tumbling. My question is, why hasn't this component been falling over the same time frame?

Perhaps there are different dynamics in the rental market. Well, the below graph indicates otherwise. The Market Tightness index is a diffusion index. Readings above 50 indicate the market is getting tighter, readings below 50 indicate that the market is easing and 50 indicates that the market is unchanged.



So, home prices have dropped, rental markets are experiencing slack, housing affordability has improved (http://www.realtor.org/research/research/housinginx), yet OER is higher? Any thoughts on this one?

Thank you.