Inflation is a general increase in the overall price of goods and services over time.
The Federal Reserve, the central bank of the United States, tracks inflation rates and inflation trends using several key metrics, including the Consumer Price Index (CPI), to determine how to direct monetary policy. A target inflation rate of 2% is considered ideal for maintaining a stable economic environment over the long run.
When inflation is on the rise and the economy is in danger of overheating, the Federal Reserve may raise interest rates to cool things down.
Interest rates reflect the cost of using someone else’s money. Lenders charge interest to borrowers who take out loans and lines of credit as a premium for the right to use the lender’s money.
Higher rates can make borrowing more expensive while also providing more interest to savers. People borrowing less and saving more can have a cooling effect on the economy.
When the economy is slowing down too much, on the other hand, the Fed can lower interest rates to encourage borrowing and spending.
What Affects Mortgage Rates?
Inflation rates don’t have a direct impact on mortgage rates. But there can be indirect effects because of how inflation influences the economy and the Federal Reserve’s monetary policy decisions. Again, this relationship between inflation and mortgage rates is related to how the Federal Reserve adjusts interest rates to cool off or jump-start the economy.
The Federal Reserve does not set mortgage rates, however. Instead, the central bank sets the federal funds rate target, the interest rate that banks lend money to one another overnight. As the Fed increases this short-term interest rate, it often pushes up long-term interest rates for U.S. Treasuries. Fixed-rate mortgages are tied to the 10-year U.S. Treasury Note yield, which are government-issued bonds that mature in a decade. When the 10-year Treasury yield increases, the 30-year mortgage rate tends to do the same.
So in terms of what affects mortgage rates, movement in the 10-year Treasury yield is the short answer. Higher yields can mean higher rates, while lower yields can lead to lower rates. But overall, inflation rates, interest rates, and the economic environment can work together to sway mortgage rates at any given time.
A simple way to see the relationship between inflation rates and mortgage rates is to look at how they’ve trended historically . If you track the average 30-year mortgage rate and the annual inflation rate since 1971, you’ll see that they often move in tandem.
They don’t always move perfectly in sync, but it’s typical to see rising mortgage rates paired with rising inflation rates.