Have you ever wondered how inflation impacts the housing market? Believe it or not, they’re connected. Whenever there are changes to one, both are affected. Here’s a high-level overview of the connection between the two.

The Relationship Between Housing Inflation and Overall Inflation

Shelter inflation is the measure of price growth specific to housing. It comes from a survey of renters and homeowners that’s done by the Bureau of Labor Statistics (BLS). The survey asks renters how much they’re paying in rent, and homeowners how much they’d rent their homes for, if they weren’t living in them.

Much like overall inflation measures the cost of everyday items, shelter inflation measures the cost of housing. And for four consecutive months, based on that survey, shelter inflation has been coming down (see graph below):

Why does this matter? Well, shelter inflation makes up about one-third of overall inflation, as measured by the Consumer Price Index (CPI). So, when shelter inflation moves, it leads to noticeable moves in overall inflation. That means the recent dip in shelter inflation might be a sign that overall inflation could fall in the months ahead.

That moderation would be a welcome sight for the Federal Reserve (the Fed). They’ve been working to get inflation under control since early 2022. While they’ve made some headway (it peaked at 8.9% in the middle of last year), they’re still trying to get to their 2% goal (the latest report is 3.3%). 

Inflation and the Federal Funds Rate  

What’s the Fed been doing to lower inflation? They’ve been increasing the Federal Funds Rate. That interest rate influences how much it costs banks to borrow money from each other. When inflation climbed, the Fed responded by raising the Federal Funds Rate to keep the economy from overheating.

The graph below shows the relationship between the two. Each time inflation (shown in the blue line) starts to climb, the Fed raises the Federal Funds Rate (shown in the orange line) to try to get it back to their target of 2% (see below):

The circled portion of the graph shows the most recent spike in inflation, the Fed’s actions to raise the Federal Funds Rate to fight that, and the moderation of inflation that happened in response to that hike. As inflation gets closer to the Fed’s current 2% goal, they may not need to raise the Federal Funds Rate much further.

A Brighter Future for Mortgage Rates?

So, what does all of this mean for you? While the actions coming out of the Fed don’t determine mortgage rates, they do have an impact. As Mortgage Professional America (MPA) explains:

“. . . 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.”

While no one can predict the future for mortgage rates, it’s encouraging to see the signs of moderating inflation in the economy. 

Bottom Line

Whether you’re looking to buy, sell, or just stay informed about the housing market, let’s connect. 

Weekly Update | June 12, 2023

Interest Rates Up Slightly

An unusually quiet week for economic news and housing data saw mortgage interest rates rise slightly. More significant rate movement was expected this week following the release of May’s Consumer Price Index (CPI) report and the latest Federal Reserve announcement. Economic data is one of the most important influences on the bond market, which determines day-to-day rate movement. Weak economic numbers typically push rates downward, and this was the case following Thursday’s Weekly Jobless Claims report. Initial filings for unemployment benefits totaled a seasonally adjusted 261,000 for the week ending June 3—well ahead of the Dow Jones estimate of 235,000 and the highest amount since late October 2021. Earlier in the week, rates moved upward following the Bank of Canada’s rate hike announcement. The bank raised its overnight rate to a 22-year high of 4.75%. The move was in response to surprisingly strong consumer spending, a pick-up in housing activity, and a tight labor market. This week’s CPI report will be one of the highly anticipated of the month. April’s reading of 4.9% marked the 10th consecutive month that the index slowed. While economic forecasters are predicting that inflation will continue to fall, it is not clear when it will drop to the Federal Reserve’s target of 2%. [Note: today's report showed May's annualized inflation at 4%, a sharp drop from April's 4.9%, and slightly lower than expected-jw] The U.S. central bank will hold its next meeting June 13 and 14. At its May gathering, the Fed raised its benchmark rate for the 10th time in 14 months. But the biggest headline to come out of the last meeting was not the rate increase but the central bank removing previous language—specifically, the phrase “some additional policy firming may be appropriate”—that signaled future rate hikes. Many economists believe that with inflation and the labor market showing signs of cooling, officials will halt the rate increases. Otherwise, they will raise the benchmark rate again, despite the growing risk that the move will trigger a mild recession. Monday’s ISM Services Index revealed that economic activity in the services sector expanded in May for the fifth consecutive month. The index reading of 50.3 was down slightly from April’s 51.9. The sector has grown in 35 of the last 36 months with the lone contraction coming in December of last year. Wednesday’s Weekly Mortgage Applications Survey from the Mortgage Bankers Association revealed that applications fell 1.4% from one week earlier. The Refinance Index was down 1% on a weekly basis and 42% lower than one year ago. Meanwhile, the seasonally adjusted Purchase Index decreased 2% for the week.

smorrison@berkshirebank.com