Have you ever pondered the correlation between inflation and the housing market? Surprisingly, they are intertwined, with alterations in one domain influencing the other. Here's a broad overview of the interconnectedness between inflation and the housing market.

The Relationship Between Housing Inflation and Overall Inflation

Housing inflation, a gauge of price increases specific to accommodation, is derived from a survey conducted by the Bureau of Labor Statistics (BLS) among renters and homeowners. The survey solicits information on rent payments from renters and asks homeowners to estimate the rental value of their homes if they were not residing in them.

Similar to how overall inflation gauges the expenses of everyday goods, shelter inflation gauges housing costs. According to the survey data, shelter inflation has witnessed a decline for four consecutive months, as illustrated in the graph below:

Why does this hold significance? Well, shelter inflation constitutes approximately one-third of the overall inflation, as measured by the Consumer Price Index (CPI). Consequently, fluctuations in shelter inflation have a discernible impact on overall inflation. The recent decline in shelter inflation may indicate a potential decrease in overall inflation in the coming months.

This moderation would be a positive development for the Federal Reserve (the Fed), which has been actively striving to manage inflation since early 2022. While some progress has been made (with inflation peaking at 8.9% in the middle of last year), the Fed is still working towards achieving its 2% inflation target (the most recent report indicates a rate of 3.3%).

Inflation and the Federal Funds Rate  

How has the Fed been addressing the inflation issue? They've been raising the Federal Funds Rate. This interest rate plays a key role in determining the cost of interbank borrowing. As inflation increased, the Fed responded by elevating the Federal Funds Rate to prevent the economy from overheating.

The depicted graph illustrates the correlation between the two variables. Whenever inflation (depicted by the blue line) begins to rise, the Fed responds by increasing the Federal Funds Rate (depicted by the orange line) in an effort to bring it back closer to their target of 2% (refer to the graph below):

The highlighted section of the graph illustrates the latest surge in inflation, the Federal Reserve's decision to raise the Federal Funds Rate in response to combat it, and the subsequent moderation of inflation following that adjustment. As inflation approaches the Fed's existing 2% target, there might be less necessity for a significant further increase in the Federal Funds Rate.

A Brighter Future for Mortgage Rates?

So, what implications does all of this hold for you? Although the decisions made by the Fed don't directly dictate mortgage rates, they do exert an influence. As elucidated by Mortgage Professional America (MPA):

“. . . 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 the future of mortgage rates remains uncertain, it is reassuring to observe indications of inflation moderating in the economy.

Bottom Line

Whether you're in the market to purchase, sell, or simply stay abreast of the real estate landscape, reach out to a local real estate expert for assistance.