Rising Home Prices Could Complicate The Fed’s Battle Against Inflation

Consecutive months of rising home prices demonstrates the resiliency of the real estate market, but it’s bad news for the Federal Reserve’s fight against inflation. 

Recent data has suggested inflation is beginning to cool, but rising housing costs could change the story and make the Fed’s job even more difficult.

Home prices are rising because demand continues to dramatically exceed the supply of available inventory. High-interest mortgage rates are keeping many buyers out of the market, but they’re also leading to low inventory as would-be sellers are reluctant to exchange their current interest rates for a higher one.

As a result, housing inventory has remained at an all-time low throughout much of 2023. With 1.08 million listings, June inventory was at a 5-month low according to the National Association of Realtors.

Shelter costs, which include both rental costs and the estimated cost of homeownership, represent about 40% of the core Consumer Price Index (CPI), which is a primary metric the Fed uses to measure inflation. Shelter costs are also reported annually, so their impact to CPI is on a lag. As a result, recent indications that inflation is cooling may not be accounting for recent increases in home prices.

While housing inflation will likely continue to soften in the near term as a result of progress on rents last year, a rebound in housing would pose an upside risk to inflation down the road,” Dallas Fed President Lorie Logan said at a June press conference.

Rising home prices often lead to higher rent costs, and if both continue to grow, the trend will eventually be reflected in key inflation data. This may lead the Fed to take more action including the possibility of additional rate hikes. After a 25-point rate increase in July, many expect the benchmark rate to end-up between 5.25% and 5.5%, but the trajectory of the housing market could lead to further tightening of monetary policy.

“If housing begins to recover more meaningfully, that raises the risk that inflation is going to be more sticky,” Apollo Global Management Chief Economist Torsten Slok said in a release. “The real risk here is, meaning from a markets perspective, that the Fed has to step harder on the brakes.”

CPI was up 3% in the 12 months ending in June, which is one-third of the rate seen a year ago, but still well off the Fed’s 2% target. While inflation does appear to be cooling after hitting a 40-year high last summer, many are concerned the core components of CPI, including shelter costs, are more stubborn and a full resurgence of home costs could send this trend in the opposite direction.

According to Redfin, the median home price as of mid-July was $382,500, which represents a 2% year over year increase. Despite rising costs and high interest rates, a growing population of buyers still need to purchase a home out of necessity due to changing careers and growing families, so demand is still growing. As a result, sellers are still seeing multi-offer scenarios; however, buyers are not offering $10,000 to $20,000 over asking price, which was the norm a year ago.

The good news is rental price trends are not yet mirroring home values, and there has been a significant uptick in new construction this year. With over 1 million rental units under construction, there is a chance the pressure on home and rental prices will decrease in the coming months. Whether or not it will be enough to keep inflation in-check remains to be seen.