U.S. housing inflation is expected to ease in the coming year as the gap between the supply and demand for homes narrows, according to a report released on Tuesday by the Federal Reserve Bank of San Francisco. This anticipated decline in housing costs is likely to exert downward pressure on overall inflation, the researchers noted in the bank’s latest Economic Letter.
Shelter inflation has been a significant driver of overall U.S. inflation in recent years, even as the Federal Reserve has aggressively raised interest rates to combat rising prices. Although higher borrowing costs typically reduce demand for housing, they also constrain supply by making construction more expensive.
While housing inflation has decreased in recent months, it remains substantially higher than pre-pandemic levels and continues to contribute significantly to overall inflation. In July, for example, shelter inflation increased by 5% year-over-year, compared to a 2.9% rise in overall consumer prices.
Research indicates that rent increases do eventually slow in response to rising borrowing costs, though the process takes time. The San Francisco Fed researchers used pre-pandemic data to forecast future shelter inflation trends and concluded that shelter inflation could drop to as low as 2% by the end of this year. However, it is expected to return to its pre-pandemic average of 3.3% next year.
“This will contribute downward pressure to inflation overall, although the extent and speed of this adjustment in shelter inflation is highly uncertain,” the researchers wrote.
The Federal Reserve is widely anticipated to begin lowering its policy interest rate later this month, following aggressive rate hikes in 2022 and 2023 that brought the current range to 5.25%-5.50%.
