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FUTURE INFLATION

It was a very quiet week for mortgage rates. There were few surprises in the economic data. Talk of easing by the European Central Bank (ECB) was positive for US mortgage rates, helping rates end the week a little lower.

Mortgage rates are primarily set based on expectations for future inflation. The Fed has an inflation target of 2.0%. Most economists think that inflation rates well above or well below this level could have negative consequences for the economy. Recent readings for core inflation have been holding steady, below 2.0%. The Core PCE price index released this week revealed that core inflation was just 1.1% over the past year. Last week’s widely followed Core Consumer Price Index (CPI) showed an annual rate of 1.6%.

The majority view on the Fed, though, is that inflation in the US will gradually climb due to an improving economy and a tighter labor market. To prevent inflation from rising too far, the Fed is on track to end its bond purchase program later this year, and Fed Chair Yellen has indicated that the first fed funds rate hike is expected to take place next year.

The situation in Europe is very different. The economic recovery has been much weaker there. Recent inflation readings have been low and appear to be heading even lower. Traditionally, the ECB is known as a stricter inflation fighter than the Fed, meaning that it is more reluctant to add stimulus. Given current economic conditions, though, officials across the euro zone have suggested that the ECB may cut rates or begin to buy bonds to help stimulate the economy and increase inflation. Increased expectations for additional ECB stimulus helped push bond yields lower around the world, including US mortgage-backed securities (MBS).

There will be some big economic events in both the US and Europe next week. A key report on inflation in the euro zone will come out on Monday. The next ECB meeting will take place on Thursday. Given the wide range of investor expectations, the ECB decision could have an impact on US mortgage rates. In the US, the important monthly Employment report will come out on Friday. As usual, this data on the number of jobs, the Unemployment Rate, and wage inflation will be the most highly anticipated economic data of the month. Before that, ISM Manufacturing, Construction Spending, ADP Employment, and ISM Services will be watched by investors.