After years of elevated housing costs contributing to inflationary pressures, relief may finally be on the horizon. Research from the Federal Reserve Bank of San Francisco suggests that U.S. housing inflation will ease in the year ahead, driven by a narrowing gap between housing supply and demand. This shift could provide much-needed relief to homebuyers and renters alike, as well as help curb broader inflation trends that have weighed on the economy.

Housing Inflation Expected to Fall in 2024

According to the Federal Reserve's research, U.S. housing inflation is likely to decline in the coming year as the imbalance between housing supply and demand continues to improve. For years, housing costs have been a major contributor to inflation, exacerbated by the effects of the COVID-19 pandemic and rising borrowing costs. The Fed’s Economic Letter highlights that while higher interest rates have cooled housing demand, they’ve also discouraged builders from increasing supply, which in turn kept housing inflation elevated.

Impact on Overall Inflation

The decline in housing inflation is expected to ease overall price pressures in the U.S. economy. The Federal Reserve has been aggressively raising interest rates to combat inflation, but shelter costs have remained stubbornly high. In July, shelter inflation was up 5% from the previous year, even as overall consumer price inflation stood at 2.9%. However, the Fed researchers suggest that a slowdown in rent increases, which usually lags behind rising borrowing costs, will help reduce inflationary pressures by next year.

Shelter Inflation Could Drop to Pre-Pandemic Levels

By analyzing data from before the pandemic, the Fed researchers predict that shelter inflation could fall as low as 2% by the end of 2024. While this would bring housing inflation closer to pre-pandemic averages, the report notes that the speed and extent of the adjustment remain uncertain. Historically, rent growth slows when borrowing costs rise, but the lag time means it may take months before the full effects of the Fed’s rate hikes are felt in housing markets.

Economic Outlook: Rate Cuts Likely

With signs that inflation is cooling, including in the housing sector, the Federal Reserve is widely expected to start cutting interest rates later this month. The central bank raised rates aggressively in 2022 and 2023, pushing its key policy rate to a range of 5.25%-5.50%. However, as inflation trends improve, many economists believe the Fed will begin to ease its monetary policy to support economic growth.

Conclusion

‍The anticipated decline in housing inflation offers a glimmer of hope for both consumers and policymakers looking to ease inflationary pressures. While uncertainties remain, the Federal Reserve's research suggests that shelter inflation will likely contribute to a broader cooling of prices over the next year. This potential shift could pave the way for rate cuts and a more balanced economy as 2024 progresses.