Inflation is picking up and looks to strengthen over the next 18 months. The Federal Reserve, in response, will accelerate short-term interest rate hikes and undo some of the quantitative easing it engaged in several years ago to shore up markets after the downturn. That means higher interest rates on bonds and mortgages and shaved returns on real estate investments. Meanwhile, you may see some potential home buyers backing off as the cost of homeownership rises. A mortgage rate jump from 4 percent to 4.5 percent adds $60 to the monthly payment on a typically priced home. On a million-dollar mortgage, the monthly increase is $300.
Why would inflation rise? For all of 2017, the consumer price index rose a manageable 2.1 percent. However, annualized rate increases have strengthened in recent months, with a 3.3 percent rise in the fourth quarter of 2017 and a 6 percent spurt in January. The recovery in oil prices is part of the reason. But persistent housing shortages are a bigger factor. Rent increases have exceeded 3 percent annually for four straight years and home prices have risen even faster. As a result, two-thirds of the country is seeing even higher prices today than during the housing bubble years. Without measurable relief for inventory shortages, housing costs will again rise above 3 percent, pulling up broad consumer price inflation.
Another source of price pressure will come from the labor market. The current 4 percent unemployment rate is, for all intents and purpose, full employment. To attract workers, companies will need to offer higher and higher wages, and some portion of those rising labor costs will get passed along to consumers. In addition, the massive tax cut and increases in government spending will also lead to more consumer spending and the need to hire more workers, further fueling price pressure. Though the inflation data is a concern, there’s an easy way to it hold down: Build more homes. More inventory will mean a slower rise in home prices and rents.