The Influence of Inflation on the Real Estate Market

Lisa Mailhot  |  August 31, 2023


The Influence of Inflation on the Real Estate Market

Have you ever pondered the repercussions of inflation on the housing market? Surprisingly, these two aspects are intertwined. Whenever there are alterations in one, both encounter an impact. Here's a comprehensive overview of the interplay between these two elements.

The Interconnection Between Housing Inflation and Overall Inflation

Housing inflation pertains to the specific price escalation within the housing sector. This data is collected through a survey conducted by the Bureau of Labor Statistics (BLS) among both renters and homeowners. The survey delves into the rent paid by tenants and the hypothetical rent homeowners would charge if they weren't residing in their properties.

Similar to how overall inflation gauges the expenses of everyday goods, housing inflation gauges housing costs. Over the past four consecutive months, as depicted in the graph below, housing inflation has been on a downward trend:


Why does this hold significance? Well, housing inflation constitutes approximately one-third of overall inflation, as measured by the Consumer Price Index (CPI). Thus, any movement in housing inflation results in discernible shifts in overall inflation. Consequently, the recent decline in housing inflation could potentially indicate an impending decrease in overall inflation in the forthcoming months.

This moderation would be a reassuring development for the Federal Reserve (the Fed). Their efforts to rein in inflation date back to early 2022. Although they have made some progress (peaking at 8.9% in the middle of the previous year), achieving their 2% target remains a work in progress (as the latest report indicates 3.3%).

Inflation and the Federal Funds Rate

What steps has the Fed taken to alleviate inflation? They have been raising the Federal Funds Rate. This interest rate influences the cost of interbank borrowing. In response to escalating inflation, the Fed increased the Federal Funds Rate to avert an overheated economy.

As illustrated in the graph below, each surge in inflation (depicted by the blue line) prompts the Fed to elevate the Federal Funds Rate (represented by the orange line) in an attempt to realign it with the 2% target (as shown below):

The circled segment of the graph highlights the most recent inflation upswing, the Fed's measures to heighten the Federal Funds Rate to counteract it, and the subsequent moderation in inflation as a consequence of that adjustment. As inflation inches closer to the Fed's 2% target, the necessity for further increases in the Federal Funds Rate might dwindle.

A Promising Outlook for Mortgage Rates?

So, how does all of this relate to you? While the actions undertaken by the Fed don't singularly dictate mortgage rates, they do exert influence. As articulated 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.

Though forecasting mortgage rates remains uncertain, the signs of inflation moderation in the economy are encouraging.

Bottom Line

Whether you're contemplating a purchase or sale, or simply aiming to stay abreast of the real estate market, let's connect.

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