First Time Home Buyer

For the first time since the subprime mortgage crisis began last summer, the Federal Reserve left their key interest rate unchanged at a low 2%. Unclear whether a slowing economy or growing inflation was a greater threat to the financial well-being of the nation, policymakers decided to wait for the effects of 10 months of lowering interest rates to be felt. They also issued a statement saying they’d be on guard against both economic decline and an inflationary price surge.

While today’s mortgage rates will not be affected, in the coming months if Fed Chairman Ben S. Bernanke and his colleagues are forced to tackle inflation, they may have to crank up rates much higher than they would if the problems were entirely domestic. Rising food and energy costs are not just limited to the United States. Those price increases are being felt across the globe.

However, rising inflation expectations are a special worry for central bankers because they signal that people have begun to assume that prices are on the way up and therefore that they should charge more for their labor or products. That is a recipe for setting off a vicious cycle of higher prices feeding still higher ones. Once inflationary expectations set in, it is a difficult process to stop.

The Federal Reserve routinely speaks of managing inflationary expectations. If the public believes that higher prices are here to stay, people will begin charging more for their labor or products. Thus the Fed tends to lean towards issuing statements that are slanted towards not only moderating inflation, but also that high prices will be coming back down.

Real world events of the past few years are completely opposite of the Fed’s forecast for moderating inflation. The price of oil has risen nearly seven fold from a low of about $20 per barrel in 2002, to a high near $140 per barrel today.

Federal Reserve policymakers are hoping that as long as the public believes the Fed will act to control inflation, today’s price increases are unlikely to feed tomorrow’s wage claims, and a wage-price spiral can be averted.

However, prices have risen significantly, even if inflation expectations haven’t. The problem is that consumers need higher wages just to match the price rises of the past few years. Until consumers’ income can catch up with rising prices, economic recovery will be elusive.

But for now, first time home buyers can enjoy low rates. Our mortgage rates predictions are for rising interest rates because of rising inflation - a forecast that is directly at odds with the most powerful central bank on Earth.

Which forecast will prove to be more accurate? Only time will tell.