A house against a backdrop of a financial chart.
Illustration by Lanette Behiry/Real Estate News

Inflation is slowing, which could soften interest rates 

Inflation rose only slightly in May to an annual rate of 4%, down significantly from its peak of more than 9% last summer.

June 13, 2023
3 minutes

Key points:

  • While still above the target rate of 2%, cooling inflation may convince the Fed to pause interest rate hikes when it meets on Wednesday.
  • NAR economist Lawrence Yun said that could ease pressure on mortgage rates: "The potential for a decline is real as we progress through the year."
  • Rising shelter costs are keeping inflation from cooling more rapidly.

Consumer prices continued to slow in May, which may foreshadow a decline in interest rates — good news for homebuyers who've been waiting for mortgage rates to come down.

The U.S. Bureau of Labor Statistics reported that the Consumer Price Index rose just 0.1% last month, the lowest rise in more than two years, and down from April's 0.4% increase.

That put the annual rate at 4%, significantly closer to the Federal Reserve's target rate of 2% compared to last summer's peak of just above 9%.

It's also the first time in two years that wage growth outpaced inflation, which should lead to an improvement in the average standard of living, said Lawrence Yun, chief economist for the National Association of Realtors.

Yun expects inflation to continue slowing, which "means that the Federal Reserve should stop raising interest rates and possibly slash rates towards the year-end or early next year." He also noted that the current yield on the 10-year Treasury bond would typically put mortgage interest rates at around 5.5%-5.7%, adding that "of course, we know the mortgage rates have been near 7% recently, but the potential for a decline is real as we progress through the year."

Housing costs — one of the largest components of the consumer price index — are keeping inflation from cooling more quickly, however. Overall shelter costs were up 8% while rent inflation was at 8.7%.

The rebounding housing market, at least in terms of rising prices, could complicate the Federal Reserve's decision regarding another rate hike in June, said Lisa Sturtevant, chief economist for Bright MLS. 

"The housing market continues to show signs of resiliency and prices may have bottomed out across much of the country. Expectations are still for the Fed to refrain from raising rates again this month, but the May inflation data and the data on home prices and rents could lead them to deliberate a June rate hike," Sturtevant said.

The Fed can do little to address housing inflation directly, as prices are rising largely due to low inventory, said Fan-Yu Ko, an economist with the National Association of Home Builders.

"Additional housing supply is the primary solution to tame housing inflation. The Fed's tools for promoting housing supply are at best limited. In fact, further tightening of monetary policy will hurt housing supply," Ko said.

The Fed will announce its decision on June 14; as of its May meeting, the Fed has raised interest rates 10 months in a row.

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