Inflation in the U.S. continued to cool last month, signaling imminent relief to homebuyers in the form of lower mortgage rates.
In the 12 months through July, the consumer price index rose 2.9%, according to data released by the Department of Labor on Wednesday. It marked the first time annual inflation has dropped below 3% since March 2021.
On a monthly basis, overall prices ticked up 0.2% from June. That gain was driven almost entirely by rising housing costs, which are reported on a delayed basis. Energy costs were flat on the month, and food prices rose modestly, ticking up 0.2% from June and 2.2% from one year ago.
For prospective homebuyers, the overall cooling of inflation toward the Federal Reserve’s 2% target is good news for mortgage rates, which have already fallen in recent weeks. The central bank is now viewed as extremely likely to begin cutting its current benchmark rate of 5.3% when policymakers next meet in September.
“Today’s data has reassured markets that they will get a rate cut in September and December,” says Realtor.com® senior economist Ralph McLaughlin. “This should put downward pressure on mortgage rates this fall and winter and will set the stage for a much better season for homebuyers in 2025.”
Mortgage rates hit their lowest level in more than a year for the week ending on Aug. 8, with the average rate on a 30-year fixed dropping to 6.47%, according to Freddie Mac.
Typically, mortgage rates follow yields on the 10-year Treasury note, which move in response to investor expectations about inflation, the economy, and future Fed rate moves. Yields on the 10-year swung between slight gains and losses in choppy trading following the new inflation data on Wednesday morning.
The Realtor.com economic team now projects average mortgage rates will fall to 6.3% by the end of this year.
Housing costs are now the biggest driver of inflation figures
Rising shelter costs accounted for 90% of the overall monthly price increases reported from June to July—but there is a major caveat due to quirks in the way shelter costs are calculated.
Shelter accounts for more than a third of the overall consumer price index, but is reported on a delayed basis that can lag up to six months. Costs for homeowners are reported as “owner’s equivalent rent,” or the estimated cost to rent the homeowner’s primary residence.
It means that inflation data for shelter may primarily reflect changes in rental markets up to half a year ago, rather than real-time changes to actual monthly costs for homeowners, who account for two-thirds of the population.
"While shelter inflation is on a disinflationary path, it is a highly lagged input into CPI so its contributions don’t reflect the current slowdown we’re seeing in the housing market," says McLaughlin. "We anticipate that as the shelter pig works its way through the CPI python, we’ll continue to get better readings through the remainder of the year."
Some economists have argued that the way housing costs are calculated has artificially boosted inflation figures, potentially prompting the Fed to wait too long to cut its benchmark rate.
"Is it possible that the Fed is too late? Until this month, the Fed seems to have been laser-focused on inflation and progress toward the 2% target. But shelter has been an outsized contributor to the consumer price index," says Bright MLS Chief Economist Lisa Sturtevant. "As the Fed has kept rates high, those higher rates have exacerbated housing costs by dampening new housing construction and increasing borrowing costs."
Sturtevant notes that, with housing costs removed from the index, the CPI has averaged just 1.7% since May 2023.
"Even with a rate cut and subsequent declines in mortgage rates, there will be some hesitant homebuyers out there who have had their finances stretched thin and have reached their affordability ceilings. The drop in rates could be too little, too late,” she says.
Could the Fed implement an emergency rate cut?
Recent economic data, including a disappointing July jobs report that sparked fleeting panic in the stock market, has spurred speculation that the Fed could issue an "emergency" rate cut before its next scheduled meeting on Sept. 18.
However, emergency rate cuts are rare and typically come only during times of extreme economic emergency.
Since the turn of the century, there have been seven emergency cuts: three in 2001 in response to the dot-com crash and the terror attacks of 9/11, and two each in response to the Great Recession in 2008 and the COVID-19 pandemic in 2020.
Financial experts are skeptical that the Fed would take emergency action before September, unless the stock market crashes dramatically or key economic indicators take a sudden nosedive.
“The next few months remain critical, even without the emergency rate cut,” says Victor Kuznetsov, managing director of Imperial Fund in Miami. “So, while the Fed will not implement an emergency rate cut, it has signaled that it may consider a larger rate cut in the near future, possibly in September, depending on how the economy evolves over the next few months.”
Indeed, bond markets are now roughly evenly split on whether the Fed will cut rates by a quarter point in September, or issue a larger half-point rate cut, according to the CME FedWatch tool.
A larger rate cut in September would likely prompt a sharper downward move for mortgage rates, spurring both more buyers and sellers to enter the market.
Read more at Realtor.com
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