The Interplay of Inflation and the Housing Market: What You Need to Know
Have you ever wondered how inflation impacts the housing market? Believe it or not, they are indeed interconnected. When changes occur in one, the other is also affected. In this blog post, we will provide you with a high-level overview of the fascinating relationship between inflation and the housing market.
The Relationship Between Housing Inflation and Overall Inflation
Shelter inflation, a measure of price growth specific to housing, plays a crucial role in this relationship. It is determined through a survey conducted by the Bureau of Labor Statistics (BLS), involving both renters and homeowners. Renters report their monthly rent expenses, while homeowners estimate how much they could rent their homes for if they weren't living in them.
Much like how overall inflation measures the cost of everyday items, shelter inflation tracks the cost of housing. Recent data from this survey shows that shelter inflation has been on a downward trend for four consecutive months. This trend matters because shelter inflation constitutes approximately one-third of overall inflation, as measured by the Consumer Price Index (CPI). Thus, fluctuations in shelter inflation can lead to noticeable shifts in overall inflation. The recent decrease in shelter inflation might be an early indication that overall inflation could decrease in the coming months.
This moderation in inflation would be welcome news for the Federal Reserve (the Fed), which has been working diligently to control inflation since early 2022. Although they have made some progress—peak inflation reached 8.9% in the middle of last year—they are still striving to reach their 2% inflation target (the most recent report pegs it at 3.3%).
Inflation and the Federal Funds Rate
But what measures has the Federal Reserve taken to curb inflation? The key tool they've employed is adjusting the Federal Funds Rate. This interest rate has a significant influence on how much it costs banks to borrow money from each other. In response to rising inflation, the Fed has raised the Federal Funds Rate to prevent the economy from overheating.
The graph below illustrates the correlation between inflation (shown in the blue line) and the Federal Funds Rate (shown in the orange line). As inflation starts to climb, the Fed raises the Federal Funds Rate in an effort to bring it back down to their 2% target.
In the circled portion of the graph, you can observe the most recent spike in inflation, the Fed's response in raising the Federal Funds Rate to combat it, and the subsequent moderation of inflation in response to that rate hike. As inflation approaches the Fed's current 2% goal, there may be less need for further increases in the Federal Funds Rate.
A Brighter Future for Mortgage Rates?
So, what does all of this mean for you, especially if you're in the housing market? While the actions taken by the Fed do not directly determine mortgage rates, they do exert an indirect influence. Mortgage rates and inflation share a connection, albeit an indirect one. When inflation rises, mortgage rates tend to follow suit to keep pace with the value of the US dollar. Conversely, when inflation decreases, mortgage rates typically follow suit by becoming more favorable.
While it's important to remember that no one can predict the future of mortgage rates with absolute certainty, it is certainly encouraging to see signs of moderating inflation in the economy. This suggests the potential for more stable or even lower mortgage rates in the future, which can significantly impact your homebuying decisions.
Whether you're looking to buy, sell, or simply stay informed about the housing market, it's advisable to connect with a local real estate expert who can provide you with valuable insights and guidance tailored to your specific circumstances. By staying informed about the interplay between inflation and housing, you can make more informed decisions in this dynamic real estate landscape.
source: adapted from keeping current matters ®, real estate blog