How Inflation Affects the Housing Market

Your Real Estate Resource

Have you ever wondered howinflationimpacts thehousing market? Believe it or not, theyre connected. Whenever there are changes to one, both are affected. Heres 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 asurveyof renters and homeowners thats done by theBureau of Labor Statistics(BLS). The survey asks renters how much theyre paying in rent, and homeowners how much theyd rent their homes for, if they werent 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 beencoming down(see graph below):

Why does this matter? Well, shelter inflation makes up about one-third of overall inflation, as measured by theConsumer 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 thatoverall inflation could fall in the months ahead.

That moderation would be a welcome sight for theFederal Reserve(the Fed). Theyve been working to get inflation under control since early 2022. While theyve made some headway (it peaked at8.9%in the middle of last year), theyre still trying to get to their 2% goal (the latest report is3.3%).

Inflation and the Federal Funds Rate

Whats the Fed been doing to lower inflation? Theyve 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 timeinflation(shown in the blue line) starts to climb, the Fedraisesthe 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 Feds 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 Feds 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 dont determine mortgage rates, they do have an impact. AsMortgage 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 formortgage rates, its encouraging to see the signs of moderating inflation in theeconomy.