Lower gasoline prices are contributing to low overall consumer price inflation. Low inflation in turn means interest rates can continue to remain at rock bottom rates. However, one weighty component in consumer prices shows an accelerating trend: namely, rents are rising at the highest pace in 7 years.
Gasoline prices have fallen by over 10 percent since summer and there could be an even further drop based on the trends in the price of crude oil. It could just as easily reverse course and suddenly rise since energy prices are always subject to unexpected global events.
Partly because of lower energy prices, the overall consumer price inflation is minimal and ideal, rising by only 1.7 percent over the past 12 months to October. This should be to the liking of the Federal Reserve, which likes to see inflation rate at slightly under 2 percent.
Apartment rents are higher by 3.3 percent, the fastest pace in nearly 6 years. Given the low and still-falling apartment vacancy rates, rents could rise even further. This trend is automatically pushing up homeowner equivalency rent as well, which is now up 2.7 percent, the fastest pace in nearly 7 years. With home building activity still well below normal, the housing market could feel shortage pressures, which means an even further rise in rents. Since the housing component is the biggest weight to the consumer price inflation, the inflation in 2015 and beyond could be a bit higher than what the policymakers are currently assuming. That means interest rates may be forced up by the Fed little sooner than planned.
Moreover, as every grocer would know, food prices are trending higher at 3 percent (with the price of meats up 13 percent).
Expect inflation to reach 3 percent sometime in 2015 and thereby force mortgage rates up to around 5 percent from current 4 percent.
Where there is high inflation banks will have to charge higher interest rates to compensate for the loss in the purchasing power of money. That is why the high 1970s-style inflation led to high mortgage rates. Later, due to government price control, lenders could not raise interest rates and many banks scrambled to come up with innovative ideas of enticing new customer deposits. The offers of free toasters and free Tupperware were the result. Many lenders still went bankrupt when the interest on money lent out was below the interest rate on deposits. Stagflation and bad economic times were the visible results of that time.
Lawrence Yun is Chief Economist and Senior Vice President of Research at NAR. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1 million REALTOR® members.