Inflation report pushes up 30-year mortgage rate
By Holden Lewis • Bankrate.com

Just when you thought mortgage rates might level off or head down, inflation pulls them back up. Well, some of them, anyway.

The benchmark 30-year fixed-rate mortgage rose for the fourth week in a row. It went up 1 basis point, to 6.57 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.41 discount and origination points. One year ago, the mortgage index was 5.86 percent; four weeks ago, it was 6.39 percent. The last time the 30-year fixed rate was this high was June 26, 2002, when it also was 6.57 percent.

The benchmark 15-year fixed-rate mortgage rose 2 basis points to 6.23 percent. The benchmark 5/1 adjustable-rate mortgage went the other direction, falling 6 basis points to 6.19 percent.

Blame inflation report
Rates on long-term mortgages would have dropped this week if not for the release Wednesday morning of the consumer price index for March. Core prices rose faster than Wall Street had been expecting, so long-term interest rates went up, too. But short-term mortgages fell on the news that the Fed might soon stop raising short-term interest rates.

On Tuesday, the Federal Reserve released the minutes from its March 28 rate policy meeting, and the document hinted that the Fed's series of 15 short-term rate hikes is about to end. Yields on long-term Treasury notes, which tend to go up and down with mortgage rates, drifted downward slightly.

Also on Tuesday, the president of the Federal Reserve Bank of San Francisco said in a speech that inflation was within her "comfort zone," that short-term interest rates were "close to a neutral stance," and that she "will be highly alert to the possibility of the policy tightening going too far." Those comments reinforced the message Wall Street gleaned from the Fed's minutes: that the central bank has probably just one more rate increase in store.

But in the speech, San Fran Fed Chief Janet Yellen added that the inflation risks are "tilted slightly to the upside." That's a signal that, on balance, she believes that high inflation is more probable than recession. "I view decisions about the path of policy going forward as quite data-dependent," she said at the Bay Area Council 2006 Outlook Conference in San Jose, Calif.

Here come the data
Then the data came in and said prices went up faster than expected in March. The prospect of higher inflation causes long-term rates to rise, and that's what happened Wednesday. But they didn't rise a lot, because the CPI isn't necessarily the most trustworthy bit of price information. Fed economists famously rely more on the core personal consumption expenditures, another measurement of prices.

"There are several measures, but it's the core PCE -- personal consumption expenditures minus food and energy -- that they're most interested in tracking," says Orawin Velz, director of economic forecasting for the Mortgage Bankers Association. "They have to keep watching it right now because the labor market is very tight and capacity utilization is the highest in six years."

A tight labor market means job-seekers and employees can fetch higher wages, and high capacity utilization means factories, mines, refineries, railroads and the like are running closer to their limits. Both are markers for inflation.

Velz says it's much too early to judge how interest rates, both short-term and long-term, will play out. The Fed is almost certain to raise the federal funds rate another quarter-point, to 5 percent, when it meets May 10, she says. After that, two CPI reports, and one or two PCE reports, will come out before the Fed meets again, on June 29.

If those reports show that inflation continues to accelerate, the Fed will raise short-term rates again June 29, to 5.25 percent. "But if core inflation slows in the next two months, that would be a good cause to pause," Velz says. She predicts that the data indeed will show a slowing economy.

Was that a sputter?
We might have seen a hint of a slowdown on Tuesday, when the report on March housing starts came in. Starts declined 6.8 percent overall, and single-family-housing starts fell 12 percent. For the first time since December, housing starts were at an annual pace of less than 2 million.

It wasn't a surprise and is no big deal, says Jeff Lyons, president of RealEstate.com. "It's still going to be an incredibly strong year," he says, adding that housing starts were stronger in the first three months of this year than they were in the first quarter of 2005, the record year.

"It's going to take us a little time to work out of the heights of the last couple of years to a more sustainable level," Lyons says. Rising interest rates "make it a little tougher for people to buy homes, so things slow down a bit."

But he still expects 2006 to be the third-strongest year on record for housing starts, after 2005 and 2004.