U.S. housing inflation is expected to decline this year as the gap between supply and demand narrows. The latest research by the Federal Reserve Bank of San Francisco says that housing inflation may decline as low as 2 percent by the end of the year before recovering to the pre-pandemic average of 3.3 percent by spring 2025.
Several factors play a role in impacting U.S. housing inflation including interest rates, supply and demand. In July 2024, data showed that housing services contributed 2.2 percentage points to a core CPI reading of 3.2 percent on a 12-month basis, excluding volatile energy and food prices. This means that a decline in housing inflation will likely add to downward pressure on overall U.S. inflation.
Higher interest rates raise costs
The high interest rate environment in the U.S. since the breakout of the pandemic has impacted housing prices all over the country. The Fed’s report explains that when interest rates rise, demand slows and prices decline. However, the supply of housing also declines in a high-interest-rate environment.
For example, higher interest rates lead to higher construction costs, primarily through financing costs, and therefore lower the returns from the lease of newly constructed units. This means higher interest rates can place opposing forces on rents, creating a tension between lower supply and lower demand for housing.
Read: U.S. existing home sales break 4-month decline streak, rising 1.3 percent in July
Household formation and completion
Leading up to the COVID-19 pandemic, household formation and completion growth began to equalize in the mid-2010s. However, since the pandemic, a considerable gap between demand and supply of housing emerged which likely put upward pressure on U.S. housing inflation.
Shelter inflation, an important component of core CPI inflation, has been slowing down in recent months. “We project that shelter inflation will continue to decline over the next few months. This will contribute to downward pressure on inflation overall, although the extent and speed of this adjustment in shelter inflation is highly uncertain,” added the report.
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