What is housing price index (HPI)? How does it affect exchange rates?

Housing prices in your city would be definitely important to you if you’re considering buying a house, or planning to take loan to buy a house. But what are the factors that influence housing prices? Can something like exchange rate fluctuations affect what price you will buy your home at? And can housing prices, in turn, impact your country’s economy and your finances?

The short answer to all those questions is, “Yes.”

This article will cover what housing price index (HPI) is, and how exactly housing prices, particularly the housing price index (HPI), affects the economy and, subsequently, the value of currency.

What is HPI? What does it measure?

Simply put, the housing price index (HPI) is a tool that measures changes in single-family home prices across a particular market. Usually, that market includes the entire housing market of a country. HPI gives a snapshot of the market in terms of which areas are seeing rising housing prices and which areas are seeing a drop. With proper understanding of this HPI, you can make estimates about whether or not a home in an area will get costlier or cheaper. These estimates also affect how much mortgage you’ll pay on your housing loan, and for how long.

In America, HPI is calculated by the Federal Housing Finance Agency (FHFA). FHFA is an agency specialized in monitoring changes in home prices across the country. The HPI in the US is not only a snapshot of home prices across the country and individual states, but also specific regions and even cities.

In the UK, too, HPI similarly measures changes in the prices of residential housing properties. HPI here includes properties in England, Wales, Scotland, and Northern Ireland. It’s calculated using data about residential property sales that are made either through direct payment or through mortgages through a housing loan.

How does the value of currency affect housing prices?

Currency’s affect on housing prices can be described in one word: inflation. Inflation is simply a change in worth of your money — what your money can buy. As you well know, prices change all the time. These variations could be related to many things — local politics, natural disasters, market fluctuations, foreign country policy changes, and more. Regardless of the reason, when the price of goods and services go up and then stay up, it’s what experts call inflation.

Housing prices, like other goods, are also affected by inflation.

Imagine that a country has a money supply of only $100, and only 10 identical houses of the same worth. Assuming that there’s nothing else to buy in this country, these houses would cost $10 each. Now, imagine that the country’s central bank prints more money and raises the total money available from $100 to $200. Now, you’d expect the prices of the houses to go up to $20 because the value of the money went down. In essence, you’re buying the same good but for more money than before. This is a rather oversimplified way to explain the relationship between inflation and housing prices.

In the real world though, there many other components that affect housing prices. One of the other major factors that causes the cost of homes to increase is interest rates. When interest rates offered on bank loans are low, buying homes can be more affordable and increase the demand for homes. If the supply of homes remains constant and the demand increases, then the prices of homes will increase. In large cities where land availability is often limited, you can see a more pronounced effect of inflation.

How does HPI influence the value of currency?

Outside of home buyers, HPI is also important for policymakers. Economists and policy experts often use HPI to analyze long-term trends in consumer behavior and the general financial situation of a country. They use HPI because changes in housing prices are an important indicator of upcoming changes in the direction of a country’s economy. It’s for this reason that HPI, along with consumer price index (CPI), gross domestic product (GDP), and unemployment figures, is also one of important indicators that currency investors keep a close watch on.

One of the ways HPI helps economists and experts detect possible future trends is by watching HPI to predict inflation. When HPI rises consistently in a nation, it can be an indication of inflation. Inflation, in turn, is a very important factor in the decisions that central banks make.

When inflation is too low, the central bank of that country usually reduces interest rates. And, on the flip side, when inflation is high, it usually raises interest rates.

When a central bank increases interest rates, households are more inclined to keep their money in the bank because of the higher returns. But raised interest rates also makes for an increased demand for that currency in the foreign exchange market. This is because if you get higher interest rates for a certain currency, then you’re more likely to invest your money there. As a result, the demand and value of that currency usually rises following an interest rate hike.

This is why investors keep a close watch on a country’s inflation figures. And because HPI is one of the indicators of inflation, each HPI release is usually followed by a fluctuation demand for a currency.

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