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December 21, 2014

A 3% Inflation Rate Will Affect Sales

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A 3% Inflation Rate Will Affect Sales

How increases in various elements of the consumer price index could affect housing in the near term.

The most recent U.S. inflation rate has clocked in at a manageable 2 percent. This level is not inherently worrisome for consumers. But pressure is building, and rates are expected to trend higher. Apartment rents and home owner equivalency rents (a fuzzy hypothetical figure of what home owners would pay to rent out their homes) are both increasing more than 2 percent annually and could soon approach 3 percent. Persistent housing shortages and falling rental vacancy rates are behind the rising rates.

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Because housing costs make up the largest part of the consumer price index, these increases are significant. But other sectors contribute to inflationary pressures, too.  Medical costs, which have been rising more gradually in recent years (they should record their slowest price gain in 40 years in 2013) are likely to head back up. Energy costs are also rising sharply. Crude oil prices were up 19 percent from a year ago, while natural gas prices jumped 23 percent.

The only component of the CPI that is falling pertains to electronic devices. And even those drops are not absolute price declines. (If a new model sells for the same price as the old model, statisticians compute it as a decrease though consumers get no price break.)

So if inflation spikes from 2 percent to 3 percent, does this create significant hardship for consumers or the overall economy? More than you might think. That’s because as inflation ticks up, so do mortgage rates. If inflation rises to 3 percent by 2015, which is more likely than not, mortgage rates will have to rise by a full percentage point to compensate lenders for the loss in purchasing power of the money returned to them. A one percentage point increase on a $200,000 loan will increase the monthly payment by $167. On a $500,000 loan, the payment rises by $417.

So yes, inflation matters and it will accelerate in 2014 and 2015. Factor this trend into your business planning, and be prepared to discuss it with your clients.

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