The Impact of Inflation on the Housing Market

Have you ever thought about how inflation affects the home market? They are, believe it or not, linked. When one is changed, the other is affected. Here's a high-level outline of the two's relationship.

The Relationship Between Housing Inflation and Overall Inflation

Shelter inflation is a measure of the price rise in the housing market. It is based on a Bureau of Labor Statistics (BLS) study of renters and homeowners. Renters are asked how much they pay in rent, and homeowners are asked how much they would rent their homes for if they weren't living in them.

Shelter inflation monitors the cost of housing in the same way that general inflation measures the cost of common products. And, according to the study, housing inflation has been declining for four months in a row (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 housing 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 has the Fed done to reduce inflation? The Federal Funds Rate has been raised. This interest rate has an impact on how much it costs banks to borrow money from one another. When inflation began to rise, the Fed responded by hiking the Federal Funds Rate in order to prevent 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 area of the graph depicts the most recent surge in inflation, the Fed's steps to raise the Federal Funds Rate to combat it, and the moderation of inflation that occurred as a result of that hike. As inflation approaches the Fed's current 2% target, they may not need to hike 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 forecast the future of mortgage rates, signs of easing inflation in the economy are positive. 

Bottom Line

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