Inflation is falling. So what happens next? Here’s what economists say

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Housing experts pointed to the latest Consumer Price Index as evidence that inflation was beginning a quick downward fall at a time when the Federal Reserve is weighing whether to continue ratcheting up interest rates.

The next few months will determine when lending and mortgage rates begin to fall, and what implications that decline might have on homebuyers, investors and consumers more broadly, economists told Inman.

CPI rose 0.1 percent in May, according to data released Tuesday by the Bureau of Labor Statistics. At 4 percent, the annual increase in the CPI in May was less than half of the 8.6 percent annual increase seen during the same month a year ago — and the lowest annual rate of increase in over two years.

The steep rise in housing costs is chief among the expenses keeping inflation high. But Tuesday’s data shows prices declining for a second-straight month, a development expected to expand into a third month, experts said.

“Shelter is still playing a big role in inflation but that should be slowing in the second half of the year,” said Jason Furman, the former director of the National Economic Council of the United States and professor of economics at Harvard. “The last two months inflation was propped up by used car prices which should be reversing.”

Inflation down by more than half from peak

The CPI hit a peak for this century with a 9.1 percent annual increase in June 2022 and has fallen gradually since then, posting a 4.9 percent increase in April and a 5 percent increase in March. Economists had expected CPI to be slightly higher this month, at 4.1 percent.

Rent and owners’ equivalent of rent account for about a third of inflation, and after a period of unprecedented increases, rent growth has been slowing for over a year. Still, it takes about a year for rent to fall out of inflation figures, which experts said is now beginning to happen.

The shelter index increased 8.0 percent compared to a year earlier and accounted for over 60 percent of the total CPI increase aside from food and energy, the BLS reported.

Jay Parsons | RealPage chief economist

“It’s still slight — for now — but trends in asking rent point to a predestined sharper down ramp for CPI Rent moving forward,” said Jay Parsons, chief economist for the rental data firm RealPage. “Asking rents for new leases serve as a leading indicator because they effectively cap where renewal increases can go. And sure enough, renewal rent increases are down to nearly half of the peak in our data, and they will continue to cool moving forward.”

National Association of Realtors Chief Economist Lawrence Yun said he expected inflation to continue falling in coming months. He said Tuesday’s report likely meant the Federal Reserve would stop raising interest rates, “and possibly slash rates towards the year-end or early next year.”

Yun said there are signs that the 30-year mortgage should be around 5.5 percent to 5.7 percent. In reality, he added, they are much higher.

“We know the mortgage rates have been near 7 percent recently,” Yun said, “but the potential for a decline is real as we progress through the year.”

End of Fed rate hikes in sight?

The Federal Open Market Committee (FOMC), which determines monetary policy, is set to meet Wednesday to decide whether inflation has improved significantly enough to pause rate hikes.

The Fed has implemented 10 consecutive rate hikes since March 2022, bringing the benchmark federal funds rate to a target range of 5 percent to 5.25 percent in an attempt to rein in inflation.

While inflation has a ways to go before reaching the Fed’s 2 percent goal, some policymakers have said they might be willing to skip a rate hike in June to assess the impact of previous rate hikes.

Tuesday report a ‘false positive?’

And while most market watchers believe the Fed won’t raise interest rates tomorrow, some economists still believe the path forward is murky.

“Even though inflation has not hit the 2 percent target sought by the Fed, the central bank could decide to forgo a rate increase this month if the FOMC members decide that the outlook for further progress on inflation looks promising,” Bright MLS Chief Economist Dr. Lisa Sturtevant said in a statement. “However, the rebounding housing market could complicate the Fed’s outlook.”

Lisa Sturtevant | Image: Bright MLS

Economists are predicting that the Fed will pause rate increases this month, but future hikes are still on the table, particularly if the housing stalemate continues. 

The vast majority of homeowners have a mortgage rate that’s far below today’s rate, according to Redfin. That has prevented people from listing their homes, and existing home sales were 23 percent lower in April than they were a year earlier. That’s helped to prevent home prices from falling despite a cooler market.

“For months, home prices and rents have been declining, which would eventually lead to lower overall inflation,” Sturtevant said. “However, the housing market continues to show signs of resiliency and prices may have bottomed out across much of the country. “

And while rent should continue falling in inflation figures, there are signs that things may pick back up again soon.

Erin Sykes | Nest Seekers International

John Burns, CEO of John Burns Research and Consulting, pointed out on Tuesday that three real estate investment trusts (REITs), which are major single-family landlords in the U.S., recently raised rents by over 7 percent. 

“Think inflation is getting under control?” Burns asked on Twitter. “Single-family rents are the largest component of CPI, which uses very old methodology with very lagging data.”

Erin Sykes, chief economist at Nest Seekers International, called Tuesday’s reading a “false positive.”

“I’m still in a wait and see mode,” Sykes said. “It’s kind of like a false positive. It’s going to get people excited and it shouldn’t. We’ve got a long way to go.”

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