After inflation slowed more rapidly than expected in November, the Federal Reserve raised the federal funds rate by 50 basis points on Wednesday to 4.25%-4.50%, a smaller interest rate hike than the 75 bps per meeting the Fed policymakers have stuck to since June. This slowdown is good news for the housing industry as it may lead to a decline in mortgage rates.

The decision from the two-day Federal Open Market Committee meeting is encouraging news for the housing market, which has suffered due to still-elevated home prices, a lack of inventory and high mortgage rates that pose affordability challenges to would-be buyers.

The Fed’s mission to fight surging inflation started in March when the central bank raised 25 bps. That rate increase was followed by increases of 50 bps in May, four straight months of 75 bps hikes in June, July, September and November, and a 50 bps increase in December. 

The central bank targets 2% inflation on an annual basis, but price increases were running at about three times that pace this year through October, based on the Personal Consumption Expenditure price index – the Fed’s preferred inflation gauge.

The Consumer Price Index, a more timely inflation measure, showed inflation slowing more rapidly than expected in November. The CPI rose 7.1% year over year in its lowest reading in a year. Year-over-year consumer price inflation peaked at 9.1% in June, but price growth has declined since then, slowing from October’s 7.7% and landing lower than economists’ expectations of 7.3% in November. 

On the back of encouraging signs that unrelenting price increases are starting to meaningfully abate, investors had speculated the moderation in price increases would lead the central bank policymakers to pursue a less aggressive policy path in 2023. 

Excluding the volatile food and energy prices, the so-called core CPI rose 0.2% from October and 6% on an annual basis, according to the Bureau of Labor Statistics. 

Services inflation, which tends to move in correlation with rising wages, remained strong due to rapid increases in rent, which rose 7.9% year over year. The labor market also remains robust, as employers added 263,000 jobs in November and unemployment levels are at 3.7%.

While the Fed’s short-term rate does not directly impact long-term mortgage rates, it does steer market activity to create higher rates and reduce demand.

Mortgage rates have been on a declining trend after peaking past 7% levels in October following slower-than-expected inflation readings that month. The 30-year fixed mortgage rate declined to 6.30% on Tuesday, according to the HousingWire Mortgage Rates Center. National Mortgage Daily showed rates were at 6.28% on Dec. 13.

Mortgage demand rose 3.2% last week, which was driven by increases in purchase and refinance activity compared to the previous week as financial markets reacted to mixed signals regarding inflation and the Fed’s next policy moves, according to the Mortgage Bankers Association.

However, with rates more than three percentage points higher than a year ago, both purchase and refinance applications are still well behind last year’s pace, said Joel Kan, vice president and deputy chief economist at the Mortgage Bankers Association. 

“At this point, mortgage rates have fallen 1%, with the markets knowing we still have some more Fed rate hikes coming,” Logan Mohtashami, lead analyst at HousingWire, said. 

The market has baked in a 50% rate hike — and that is “the right call” after the weaker CPI reading, he added.

“The ongoing moderation in home-price growth, along with further declines in mortgage rates, may encourage more buyers to return to the market in the coming months,” Kan said. 

The MBA expects the average 30-year fixed mortgage rate to fall to 5.2% in 2023. The latest MBA forecast showed mortgage rates will finish the year at 6.7%.

The next two-day FOMC meeting is scheduled for January 31 and February 1.