How Inflation Affects the Housing Market

Oriana Suarez September 12, 2023


How Inflation Affects the Housing Market

How Inflation Affects the Housing Market

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

The indicator of price growth specifically for housing is called shelter inflation. It originates from a Bureau of Labor Statistics (BLS) poll of homeowners and renters. Renters are asked how much they pay in rent, and homeowners are asked how much they would charge for their homes if they weren't residing in them.

Shelter inflation tracks the cost of housing in a manner similar to how overall inflation tracks the cost of basic necessities. Based on that study, the cost of housing has decreased for four straight months (see graph below):

Why is this important? Inflation in housing accounts for almost one-third of overall inflation, according to the Consumer Price Index (CPI). Therefore, changes in shelter inflation result in changes that are seen in total inflation. That is why the recent decline in shelter inflation may be a precursor to a future decline in total inflation.

The Federal Reserve (the Fed) would be happy to see such moderation. Since the beginning of 2022, they have been attempting to curb inflation. Despite considerable progress (it reached a height of 8.9% in the middle of last year), they are still working to reach their 2% target (the most recent figure is 3.3%). 

Inflation and the Federal Funds Rate  

To combat rising inflation, the Federal Reserve has implemented a strategy of increasing the Federal Funds Rate. This key interest rate directly impacts the cost of borrowing money from banks from one another. When inflation begins to rise, the Fed's response is to raise the Federal Funds Rate as a measure to prevent the economy from overheating.

The relationship between the two is depicted in the graph below. The Federal Reserve raises the Federal Funds Rate (shown in the orange line) every time inflation (shown in the blue line) begins to increase in an effort to bring it back to its objective 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.

Implications 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 of 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, connect with one of our local real estate experts who can help. Your real estate dreams are our top priority, and our realtors are here to turn them into reality. Don't hesitate – get in touch with us today and let's start the conversation that leads to your next success story in the world of real estate.


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