Inflation is back in force

Inflation hit 6.8% in November, its highest level since the ancient era of Reaganomics and the United States’ war on inflation. If prices continue to skyrocket, mortgage rates will also rise. But there is also a silver lining in this cloud for borrowers.

The current combination of low mortgage rates and high inflation is extremely rare. So one of those conditions is likely to end soon – and if prices stay high, economists say, mortgage rates will rise.

“Inflation tends to push mortgage rates up, so I expect we will enter the new year with rates higher than those we ended 2021 with,” said Ralph McLaughlin, chief economist at Haus.com.

Last week’s 6.8% inflation rate was the highest in 39 years, and there is little relief in sight. Consumer prices are set to continue to climb, said Frank Nothaft, chief economist at real estate data firm CoreLogic.

And that means mortgage rates will definitely go up. “We’re going to see continued upward pressure on rates,” Nothaft said.

While the annual inflation rate exceeded 4% in the spring, then 5% this summer, the Federal Reserve called the phenomenon “transient”.

The central bankers’ initial analysis looked like this: The global economy slowed sharply in March 2020. Consumers stopped eating out, traveling, and engaging in other typical spending patterns, creating a period deflation. At the same time, the federal government has filled consumers’ bank accounts with stimulus money, paving the way for prices to spike once pandemic lockdowns are eased.

As economic activity returned to normal, it was believed that prices would inevitably rise. After all, annual inflation is just a comparison to prices from a year earlier. And this year’s consumers are spending a lot more than they were a year ago. But once the consumers ran out, the transient argument was gone, everything would return to normal.

This is not what is happening, however. Shortages persist for all kinds of goods, including cars, appliances and building materials. The Fed no longer qualifies inflation as temporary.

CoreLogic’s Nothaft sees inflation as a threat to historically low mortgage rates, and he sees signs that inflation will be with us for some time. Yes, it’s possible that supply chain issues will finally ease, slowing the price growth of cars, lumber and other items. But these goods are only part of the inflation index. The federal consumer price measure also includes housing and health care – and neither of those items will see prices drop when auto production returns to normal and port safeguards end.

“It makes it very, very difficult to bring inflation down to the Fed’s 2% target,” Nothaft said.

For now, the unusual combination of high inflation and low mortgage rates makes borrowing more attractive. This is because if long-term rates do not rise as prices rise, the “real” cost of paying off today’s mortgage decreases over time.

Simply put, inflation is generally good news for borrowers, especially those with mortgages. You can repay the loan in ever cheaper dollars, which reduces the cost of borrowing.

The image of inflation is important for mortgage rates because it could strain the Fed’s hand. If inflation remains high, the Fed would be forced to raise interest rates in 2022. Indeed, on Wednesday, it forecast three interest rate hikes next year.

The central bank does not control mortgage rates, which are closely tied to 10-year Treasury bills. While the Fed’s decisions don’t determine mortgage rates as directly as other products, like savings accounts and CD rates, the Fed’s actions indirectly influence the rates consumers pay on their home loans. at a fixed rate.

“Mortgage rates move with long-term bond yields,” says Greg McBride, chief financial analyst at Bankrate. “If investors think inflation is going to subside and not be a problem in the longer term, it leads to a more subdued response from mortgage rates despite the ugly inflation numbers we are seeing now.”

In other words, a surge in mortgage rates is not a sure thing. But surging consumer prices certainly make a rate hike more likely.

“Soaring inflation is prompting the Fed to change course, no longer calling it transient and likely doubling the pace of their decline at this week’s meeting,” McBride said. “Inflation is a short-term problem, but if the Fed acts to bring it under control, it won’t be a longer-term problem and won’t necessarily cause mortgage rates to spike. But the Fed’s credibility is key to it all – and their credibility has taken a hit lately. “

What it means for borrowers and mortgages