How Inflation Impacts the Housing Market

Have you ever wondered how inflation can affect the housing market? It may come as a surprise, but they are connected. Whenever there are changes to one, both are impacted. Here is a high-level overview on exactly how inflation and the housing market are connected.

The Relationship Between Housing Inflation and Overall Inflation

There are several aspects of inflation, and shelter inflation specifically measures the price growth for housing. This information comes from a survey of renters and homeowners that’s done by the Bureau of Labor Statistics (BLS). The survey asks homeowners how much they’d rent out their homes for if they were not living in them, and it asks renters how much they are paying in rent.

Similar to how overall inflation measures the costs of everyday items, shelter inflation measures the cost of housing. Earlier in 2023, there was a four month period where shelter inflation was coming down.

Why does that matter? Believe it or not, but shelter inflation composes roughly one-third of overall inflation, as measured by the Consumer Price Index (CPI). This means that when shelter inflation moves, it leads to noticeable changes in overall inflation. This means that the recent dip in shelter inflation may be a sign that overall inflation could also fall in the upcoming months.

If overall inflation were to decrease, it would be a welcome sight for the Federal Reserve. They’ve been working hard to get inflation under control since early 2022, and while they have made some headway (it peaked at 8.9% in the middle of 2022), they are still attempting to get to their goal of 2% (with one of the latest reports showing 3.7%).

The Federal Funds Rate and Inflation

You may be wondering what the Federal Reserve may be doing to lower inflation, and the answer is that they have been increasing the Federal Funds Rate. That interest rate influences how much it costs banks to borrow money from each other. When inflation climbs, the Federal Reserve can respond by raising the Federal Funds Rate to keep the economy from overheating.

The graph below shows the relationship between the two. Displayed in blue, each time inflation starts to climb, the Federal Reserve raises the Federal Funds Rate (displayed in orange) to try and reach that 2% target rate.

The circled portion of the graph shows one of the most recent spikes in inflation, the Federal Reserve’s actions to raise the Federal Funds Rate to counteract that, and the moderation of inflation that happened in response to that rate hike. As inflation approaches the 2% goal, they may not need to raise the Federal Funds Rate much further.

Is a Brighter Future for Mortgage Rates on the Horizon?

So, what does this mean for you and mortgage rates? While the actions of the Federal Reserve don’t directly determine mortgage rates, they do have an impact. An expert from Mortgage Professional America (MPA) explains that:

“...mortgage rates and inflation are connected, however indirectly. When inflation rises, mortgage rates rise to keep up with the value of the US dollar. When inflation drops, mortgage rates follow suit.”

So, while no one can predict the future for mortgage rates, it is still encouraging to see the signs of moderating inflation in the economy.

In Conclusion

If you have any additional questions on how mortgage rates work, contact Dianne Anderson, an award winning real estate professional with Premier Sotheby’s.

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