How Inflation Affects the Housing Market

Have you ever wondered how inflation impacts the housing market? Believe it or not, the two are linked. When a change occurs in one, both are affected. Here’s an overview of the relationship between these two and how this affects you as a homeowner.

The Correlation Between Housing Inflation and Overall Inflation

Have you ever heard the term “shelter inflation”? This is the measure of price growth specific to housing. It comes from a survey done by the Bureau of Labor Statistics (BLS). The survey asks renters how much they’re currently paying and homeowners how much they would rent their homes for if they weren’t living in them.

Similarly to how overall inflation measures the cost of everyday items, shelter inflation gauges the cost of housing. Based on that survey, shelter inflation has been decreasing for four consecutive months(see graph below):

Why does this matter? When shelter inflation changes, it leads to noticeable shifts in overall inflation. This influence is because shelter inflation makes up about one-third of overall inflation, as calculated by the Consumer Price Index (CPI). Knowing this connection, the recent dip in shelter inflation could indicate that overall inflation might drop in the coming months.

For the Federal Reserve (the Fed), which has been working to get inflation under control since early 2022, such a moderation would be a welcome sight. While there has been some progress, with inflation peaking at 8.9% in the middle of last year, they still have not met their 2% goal. The most recent report is 3.3%. 

Inflation and the Federal Funds Rate  

So what has the Fed been doing to reach this goal? They’ve been increasing the Federal Funds Rate. This interest rate affects how much it costs banks to borrow money from each other. When inflation rose, the Fed raised the Federal Funds Rate to keep the economy from overheating.

The graph below illustrates the relationship between the Federal Funds Rate and inflation. 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 its target 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. As inflation gets closer to the Fed’s current 2% goal, there might not be a need to keep increasing the Federal Funds Rate.

A Brighter Future for Mortgage Rates?

So, what does all of this mean for you? The current actions of the Fed don’t determine mortgage rates, but they still 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.”

No one can predict the future of mortgage rates. However, noticing signs of moderating inflation in the economy is encouraging. 

Bottom Line

Are you looking to buy, sell, or stay informed about the Kansas City housing market? The Just Say Home real estate experts are well-informed about the current market and equipped with the knowledge to help you make the best decision moving forward!