Why does higher inflation (CPI) make mortgage rates go up?

Question

Why does higher inflation (CPI) make mortgage rates go up?

Answer 1

The CPI is a measure of inflation at the consumer or retail level.

Now when you have inflation, it means that consumers are spending too much. As consumers increase their spending and demand more, suppliers raise their prices and sell more.

However, you reach a point where consumer spending gets out of control and becomes worrisome. And that's when the Fed steps in and deals with. How? By raising rates as a way to make it more costly to spend.

In other words, if your credit card rates go up, you'll use the cards less and spend less. So the spending by consumers will decrease and inflation will be under control.

So how does this effect mortgage rates? When the Fed increases rates, the prime rate goes up too. And mortgage rates are based on the prime. So when the prime rate goes up, mortgages follow.

Answer 2

Higher inflation means that if you pay a fixed amount each month, the fixed amount will be worth increasingly less.  To make up for this, banks charge higher interest rates on mortgages when inflation increases.

There's the real interest rate and the nominal interest rate.  The real interest rate is the nominal interest rate minus the rate of inflation.  So the real interest rate wouldn't necessarily change, but the nominal rate would because of the lowered future value of money.

Answer 3

Your question is improperly worded.

CPI does not measure inflation, it measures prices (and not very well).  Inflation is an increase in money supply.

And increase in money supply lowers interest rates because the number of foreign holders of dollars attempting to "invest" those dollars in debt instruments (government bonds, corporate debt, mortgages, etc) increases.  As the demand for debt tends to increase, the price of debt instruments tends to increase, and rates tend to drop.

Answer 4

inflation means that money today is worth more than the same amount of money tommorrow, so just as in the other question, it will make mortgage rates rise.

Answer 5

There are a couple of ways to answer this question:

First in terms of purchasing power, because a lender is giving up purchasing power today they must be compensated via the nominal interest rate. The higher the rate of inflation if the bank does not charge a higher interest rate they will lose purchasing power. This was the premise for ARM's in the 1980's. Also a popular equation in economics is the Fisher Equation. The fisher equation shows the Nominal Interest Rate equals the Real Interest Rate plus Expected Inflation. The nominal interest rate is the advertised rate while the real rate is what the bank wants to earn. As inflation increases the nominal interest rate will also increase.

Answer 6

A 30 Yr Mortgage is really a 30yr bond. If inflation (as dictated by CPI) rises, than it becomes less profitable to create a low yielding bond/mortgage if they don't raise the interest rate.

So as inflation grows, so will the interest rates. As inflation declines, competition will drive rates lower.

Fed Funds Rate does not have a direct impact on mortgage rates.