The Impact of Inflation on Mortgage Rates

When reading about the housing market in the news, you might come across references to recent decisions made by the Federal Reserve (the Fed). But how do these decisions affect your plans to buy a home? Here's what you need to understand.

The Fed is making significant efforts to reduce inflation. However, despite a cooling trend in inflation over the past 12 months, the latest data still indicates inflation remains higher than the Fed's target of 2%  (see graph below).

While you might have hoped that the Fed would halt their rate hikes as they make progress in curbing inflation, they are cautious not to stop too soon, fearing that inflation might rise again. Hence, the Fed recently decided to increase the Federal Funds Rate. As Jerome Powell, Chairman of the Fed, says:

“We remain committed to bringing inflation back to our 2 percent goal and to keeping longer-term inflation expectations well anchored.”

Greg McBride, Senior VP, and Chief Financial Analyst at Bankrate, explains that the persistence of high inflation may be influenced by the economy's resilience and robust labor market: 

“Inflation remains stubbornly high. The economy has been remarkably resilient, the labor market is still robust, but that may be contributing to the stubbornly high inflation. So, Fed has to pump the brakes a bit more.”

Although a Federal Fund Rate hike doesn't directly determine mortgage rates, it does have an impact. As a recent article from Fortune says:

“The federal funds rate is an interest rate that banks charge other banks when they lend one another money . . . When inflation is running high, the Fed will increase rates to increase the cost of borrowing and slow down the economy. When it’s too low, they’ll lower rates to stimulate the economy and get things moving again.”

Implications for You

Simply put, when inflation is high, mortgage rates also tend to be high. However, if the Fed successfully reduces inflation, it could lead to lower mortgage rates, making homeownership more affordable.

This graph helps illustrate that point by showing that when inflation decreases, mortgage rates typically go down, too (see graph below): 

According to the information presented above, inflation (depicted by the blue trend line) is gradually decreasing, and based on past patterns, mortgage rates (represented by the green trend line) are expected to follow suit. McBride provides his insights on the potential trajectory of mortgage rates in the future.

Bottom Line

The movement of mortgage rates is closely tied to inflation. If inflation subsides, mortgage rates are likely to decrease as well. For expert advice on housing market changes and their implications for you, let's have a conversation.