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How Inflation Intersects with the Housing Market

Have you ever pondered over the intricate relationship between inflation and the housing market? Surprisingly, these two economic factors are intricately connected, and changes in one invariably influence the other. Here's a concise overview of the interplay between inflation and the housing market:

1. The Relationship Between Housing Inflation and Overall Inflation

Shelter inflation, a specific measure of price growth in the housing sector, is derived from a survey conducted by the Bureau of Labor Statistics (BLS). This survey collects data from both renters and homeowners, inquiring about rent payments and the hypothetical rental value of their homes if they weren't occupying them.

Much like how overall inflation quantifies the cost of everyday items, shelter inflation gauges the cost of housing. Interestingly, shelter inflation accounts for roughly one-third of the Consumer Price Index (CPI), which measures overall inflation. Recent data from the survey has shown a decline in shelter inflation for four consecutive months.

Why is this significant?

Because changes in shelter inflation can have a notable impact on overall inflation. Thus, the recent decrease in shelter inflation could be a signal that overall inflation might decrease in the coming months. Such moderation would be a welcomed development for the Federal Reserve (the Fed), which has been striving to control inflation since early 2022. Although they've made progress (inflation peaked at 8.9% in the middle of last year), they're still working towards their 2% inflation target (the latest report indicates 3.3%).

2. Inflation and the Federal Funds Rate

To combat rising inflation, the Fed has been raising the Federal Funds Rate, an interest rate that influences interbank borrowing costs. When inflation surges, the Fed responds by increasing the Federal Funds Rate to prevent the economy from overheating. The graph below illustrates this relationship, with inflation represented by the blue line and the Federal Funds Rate by the orange line. Whenever inflation starts to rise (as highlighted in the circled portion of the graph), the Fed responds by raising the Federal Funds Rate to bring it closer to their 2% target.

As inflation inches closer to the Fed's target, they may find less need to raise the Federal Funds Rate further.

3. A Glimmer of Hope for Mortgage Rates

While the Fed's actions don't directly dictate mortgage rates, they do exert an indirect influence. Mortgage rates and inflation share a connection, albeit an indirect one. When inflation escalates, mortgage rates tend to rise to align with the value of the US dollar. Conversely, when inflation recedes, mortgage rates tend to follow suit.

While it remains impossible to predict the exact trajectory of mortgage rates, it's heartening to observe indications of moderating inflation in the broader economy.

In Conclusion

Whether you're contemplating buying, selling, or merely seeking to stay informed about the housing market's dynamics, it's prudent to establish contact with a local real estate expert. They can provide invaluable insights into how these economic factors may impact your housing decisions.


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