By Omar Mohammed
Reporter, Economy & Finance
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Inflation in May came in cooler than expected, the U.S. Bureau of Labor Statistics revealed on Wednesday, a development that could spur a downward trend in borrowing costs that have been elevated to two-decade highs, stifling the housing market, and making the prospect of buying a home unaffordable for a lot of Americans.
Read more: How to Calculate How Much House You Can Afford
The Consumer Price Index (CPI) last month accelerated by 3.3 percent on a yearly basis which was unchanged compared to April. Core CPI, which excludes the volatile energy and food prices, slowed to 3.4 percent as it increased by lower than expected 0.2 percent for the month. In April, that data point had hit 3.6 percent, according to the Bureau of Labor Statistics.
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Borrowing costs across the economy shot up after the Federal Reserve hiked rates at an aggressive pace starting two years ago to battle soaring inflation that at one point rose to its highest level in 40 years. Mortgage rates have gone up since then and currently sit at around 7 percent, double where it was only four years ago.
Read more: Step-by-Step Guide on How to Qualify for a Mortgage
May's inflation suggests that price increases had softened in the month and the market's immediate reaction was welcoming. The 10-year treasury yield, which mortgage rates tend to follow, fell on the news of cooling inflation, which economists suggest could spur a decline in borrowing costs.
"Absolutely possible. Today's CPI reading was pretty good around the board," Danielle Hale, Realtor.com's chief economist, told Newsweek.
Hale noted that the fall in the 10-year yield could shape the trajectory of mortgage rates. As of 9.54 a.m. EST, it had dropped by more than 10 basis points, according to Yahoo Finance, down close to 2.8 percent from where it opened.
Read more: First-Time Homebuyer Guide
"You know, we could see that reflected in mortgage rates, they could drop by a similar magnitude," Hale said.
One signal of how sensitive the mortgage market is to even the slightest movement in rates came on Wednesday from lenders who reported that a downtick in the cost of home loans sent applications for mortgages soaring for the week ending June 7.
Mortgage rates had fallen to the mid-6 percent by the end of 2023 and to start the year after rising to the highest levels since the start of the century in the fall of last year, on the back of cooling inflation that created expectations that the Federal Reserve would begin slashing rates.
But price increases in the first quarter of 2024 dampened prospects of cuts in borrowing costs, as central bank policymakers suggested that they needed more confidence that inflation was on a consistent move toward their target of 2 percent before they could kick-start a reduction in rates. That helped push mortgage rates up again to near and around 7 percent.
"Between falling energy prices, and relatively little change in food prices, we've gotten some long-awaited better news on inflation," Mark Hamrick, senior economic analyst at Bankrate, told Newsweek. "The Federal Reserve doesn't yet have full confidence that inflation is coming down closer to its 2 percent target. But it can see a possible path how to get there."
Hamrick suggested that CPI and the upcoming producer prices data will suggest there was progress on inflation.
"There's a lot of data yet to digest before we get there, but the odds currently favor a cut in benchmark rates when the Fed meets in September, with a meeting scheduled before that in late July," he said. "If it happens, that will dampen economic headwinds ever so slightly, including a modest reduction in borrowing costs."
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Fed policymakers have been meeting this week and are scheduled to provide an update on interest rates. Analysts expect that the central bank is set to keep rates unchanged at their current two-decade high of 5.25 to 5.5 percent range for the seventh time in a row.
But some economists suggest that May's inflation reading suggests it was time for the Fed to cut rates.
"What it should mean is that the Federal Reserve should cut interest rates," Bilal Baydoun, Groundwork Collaborative's director of policy and research, told Newsweek. "I mean, they had forecasted three cuts this year and I don't see a reason to keep searching for data that isn't going to come in part because the high interest rate environment is strangling the housing market."
High borrowing costs have made the housing market unaffordable for a significant chunk of Americans, Baydoun said.
"Mortgage lock-in, where people don't want to sell their homes because they have a better rate, that's I think the highest it's been in a quarter century," he told *Newsweek. "*So all of these factors really do the opposite of bringing down costs."
Lowering interest rates would help bring down the cost of home building and contribute to more supply of houses available in the market whose low inventory has contributed to a jump in prices, Baydoun added.
"We have an affordability crisis I think in housing that the Fed is effectively pouring gasoline on that fire," he told Newsweek. "Again this is outside of the Fed's purview, I want to be very clear, but housing plays a major role in the sort of psyche of Americans about how they feel about their future."
The state of the housing market can shape how people feel about the country's financial status, he added.
"When people look around and see mortgage rates at 7 percent, that has the effect of stifling people's sort of aspirations, of really dampening people's confidence in the economy overall," Baydoun said.
In a sign of how the cost of housing is shaping inflation, shelter costs continue to be elevated in May.
"More than offsetting a decline in gasoline, the index for shelter rose in May, up 0.4 percent for the fourth consecutive month," the Bureau of Labor Statistics pointed out.
Realtor.com's Hale suggested that housing costs could present a risk for Fed policymakers as they contemplate when to cut rates.
"The one area that was highlighted in the release as being really stubborn and not budging was shelter inflation," she told Newsweek. "Asking rents continue to decline, but at a slower pace. So, that could signal that shelter inflation might stall out, and if it does so at a relatively high level, that could prove challenging for the Fed in the months ahead."
Baydoun suggested that inflation proving sticky is driven by housing costs and why the Fed needed to cut rates sooner rather than later.
"Inflation is being driven primarily by the shelter portion of the index, which continues to account for the largest share of the rise in prices," he said.
"What they should do is look at that data and move up their sort of thinking around when a rate cut should should occur. I'm not sure that's what will happen though, but I hope it does."
Update 06/12/24, 1:50 p.m. ET: This article was updated with a chart and more context.
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