Inflation is back: but does that mean mortgage rates are going to rise?


Over the past four decades, through protracted wars, bitter elections, and economic booms and recessions, American consumers could count on this constant: The inflation rate has remained below the average mortgage rate of 30 years.

That changed last month. The pace of inflation in the United States jumped to 4.2 percent, according to the United States Bureau of Labor Statistics. The typical 30-year mortgage, on the other hand, costs just over 3%.

It was the first time since August 1980 that U.S. inflation was higher than mortgage rates. That summer was the trough of the stagflation era, and it came just before the Federal Reserve embarked on an aggressive strategy to control soaring inflation – a move that came close to the federal funds rate. crippling by 15% in the last breath of the Jimmy Carter administration.

Although the rate of inflation does not determine mortgage rates, the two measures are correlated. And it’s not hard to imagine that a sustained surge in consumer prices would be accompanied by a rise in mortgage rates, which hit record lows in January.

Inflationary threat looks modest for now

What, if any, does this turnaround mean for mortgage borrowers? The answer is not yet clear, but many housing economists argue that rising inflation does not look like a long-term threat but a normal correction after last year’s sharp drop in spending.

“I’m not worried about the implications of the 30-year lower rate of inflation for several reasons,” says Ralph McLaughlin, chief economist at “Firstly, it is not unusual for the 30-year mortgage rate and the inflation rate to move closer to each other after coming out of a recession, and secondly, inflation seems quite high due to the severe deflation we experienced at this time last year. “

The impact of inflation on mortgage rates also depends in part on the continued sharp rise in consumer prices.

“The Federal Reserve believes the price spike is temporary and that price increases will subside as supply catches up with demand,” said Lynn Reaser, chief economist at Point Loma Nazarene University. “The relatively subdued response from the bond market indicates that it broadly believes in this view, which has affected markets for long-term bonds, such as mortgages.”

This explains why mortgage rates did not rise sharply after the federal government announced the highest rate of inflation in years.

Greg McBride, chief financial analyst at Bankrate, takes the rising inflation in stride. Comparing prices in the midst of this spring’s recovery to those of last spring’s slump, the Consumer Price Index looks – ahem – inflated.

“The year-over-year inflation rate has been boosted by what is known as the base effect – the fact that price levels actually fell a year ago distorts the comparison with levels from a year ago, ”McBride said. “This phenomenon can persist for two to three months given the drop in prices of a year ago and the surge in economic activity today. But it is more of an anomaly than a lasting condition.

Are the prices overheating?

However, there are early signs that prices may continue to rise. In the United States and around the world, massive government stimulus measures have pumped money into the pockets of consumers. Meanwhile, home and stock prices have skyrocketed, making affluent consumers richer. And the costs of raw materials such as wood and steel have also skyrocketed.

“If price increases don’t start to moderate over the next few months, mortgage rates could rise dramatically,” Reaser said.

There is no clear consensus on the outlook for inflation. Janet Yellen, former Fed chief and current Treasury secretary, recently warned that the US economy could overheat. Current Fed Chairman Jerome Powell is not so worried.

Neither does Todd Metcalfe, an economist at Moody’s Analytics. “While we expected inflation to be high relative to recent history, we expect it to fall below 3% this year and continue to decline before settling near 2% over the next two years, ”he said.

Homebuyers, on the other hand, could be forgiven for pointing out that the official inflation rate doesn’t quite reflect the challenges they face. The median home resale price hit a record 19% from April 2020 to April 2021, after jumping 17% from March 2020 to March 2021, but house prices are not directly reflected in the housing index. consumer prices.

“When house prices rise and rents rise at a relatively more moderate rate, one could argue that inflation is underestimated,” McBride said.

Inflation disappeared decades ago

Inflation has not threatened the US economy for decades. The last time rising prices posed a threat was in 1991, when the rate hit 4.2 percent. Since then, inflation has only averaged 2.3%, according to World Bank data. This number is roughly in line with the Federal Reserve’s inflation target of 2%.

The massive stimulus from the Great Recession predicted that inflation would eventually return, but those fears turned out to be unfounded. Despite a spasm in spending by the world’s largest economies, inflation has remained contained.

On the contrary, the US government cash machine ran even harder during the coronavirus pandemic. Former President Donald Trump and current President Joe Biden have both signed stimulus packages, and the Fed has backed the mortgage market.

All of that money is going to pour into the real estate market in the years to come. Real estate is generally viewed as a hedge against inflation, so home values ​​are likely to hold up in times of higher prices.

Even if inflation does not turn into a long-term problem, its recent return indicates that mortgage rates should continue to rise.

“If inflation stays at a higher level, mortgage rates will eventually rise as well,” McBride said.

For homeowners, the message is clear: you are unlikely to find a better deal on refinancing in the future. “The big thing for consumers to remember right now,” says McLaughlin, “is to refinance your mortgage if you haven’t already.”

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