Low existing inventory that is keeping demand solid for new homes helped to push builder confidence up in July even as the industry continues to grapple with rising mortgage rates, elevated construction costs and limited lot availability.

Builder confidence in the market for newly built single-family homes in July posted a one-point gain to 56, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) released today. This is the seventh straight month that builder confidence has increased and marks the highest level since June of last year.

“The lack of resale inventory means prospective home buyers who have not been priced out of the market continue to seek out new construction in greater numbers,” said NAHB Chairman Alicia Huey, a custom home builder and developer from Birmingham, Ala. “At the same time, builders are troubled over rising mortgage rates approaching 7% and continue to grapple with supply-side challenges, including ongoing scarcity of electrical transformer equipment and growing concerns about lot availability.”

“Although builders continue to remain cautiously optimistic about market conditions, the quarter-point rise in mortgage rates over the past month is a stark reminder of the stop and start process the market will experience as the Federal Reserve nears the end of the ongoing tightening cycle,” said NAHB Chief Economist Robert Dietz.

Given that shelter inflation accounts for roughly 40% of the Consumer Price Index, Dietz added the best way to ease this largest source of inflationary pressure is to build additional for-rent and for-sale housing. “There’s been some commentary linking gains for housing construction with increased concerns for additional inflation, but this has the economics backwards,” he said. “More housing supply is good news for future shelter inflation readings in the market. Furthermore, higher interest rates increase the cost of financing for building homes and developing lots.”

The July HMI survey also revealed that despite elevated interest rates, builders’ use of sales incentives has declined, as the market has firmed and resale inventory options remain limited. Only 22% of builders report cutting prices in July. This is down from 25% in June and 27% in May.

Derived from a monthly survey that NAHB has been conducting for more than 35 years, the NAHB/Wells Fargo HMI gauges builder perceptions of current single-family home sales and sales expectations for the next six months as “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.

The HMI index gauging current sales conditions in July rose one point to 62, the component charting sales expectations in the next six months fell two points to 60, and the gauge measuring traffic of prospective buyers increased three points to 40, the highest reading since June of last year. However, the decline for the future sales expectation reading is a reminder that housing affordability continues to be challenged by elevated interest rates.

Looking at the three-month moving averages for regional HMI scores, the Northeast increased five points to 52, the Midwest edged up two points to 45, the South increased three points to 58 and the West posted a five-point gain to 51.