Interest rates will fall, but not to the level many homeowners now consider normal, says HAMISH MCRAE
OK. What happens now? Last week, the Bank of England shocked financial markets, and many homebuyers, by raising interest rates by half a percent instead of a quarter.
Instead of doing the minimum that the markets expected, it did a little more. Finally, the majority of the Monetary Policy Committee is coming to the conclusion that it has failed to raise rates fast enough, even though two outside members – both professors at the London School of Economics – have voted in favor of no change. There is a gulf between some academics and the real world.
Rates are likely to go even higher. The yield on one-year gilts is about 5.25 percent and the yield on two-years is just over 5 percent. That drives up the cost of borrowing for everyone. If it costs the government more than 5 percent to borrow for two years, it costs a mortgage payer about 6 percent. Even the most creditworthy house buyer has to pay a little more than His Majesty’s Government.
What happens next?: Rates are likely to go even higher, but the first cut is expected in the first half of next year
The challenge now is to prevent higher interest rates from affecting the economy. Actually, he’s not doing too bad, considering everything that’s been thrown at it. Retail sales rose slightly in May and the forward looking purchasing managers index points to continued sluggish growth.
Some people will still have built up a cash cushion during the pandemic when they couldn’t spend their income, and cash is finally starting to yield some interest. But many families will have to make cuts and there is rightly great pressure on mortgage lenders to prevent people from being evicted.
Let’s not forget that most people who bought two or more years ago will have a profit in their house, albeit only a paper house, until they sell. Over the life of a 25-year mortgage, there will be a valuable asset at the end.
Maintaining a reasonable level of confidence in the housing market is very important, because what happens there is a major determinant of consumer confidence. Private consumption is about 65 percent of gross domestic product, and we will need confident consumers to get us through the times when rates can begin to fall.
| May 2022 | October 2022 | May 2023 | May 22, 2023 | June 5, 2023 | |
|---|---|---|---|---|---|
| Average fixed mortgage for two years | 3.03% | 5.43% | 5.26% | 5.34% | 5.72% |
| Average fixed mortgage for five years | 3.17% | 5.23% | 4.97% | 5.01% | 5.41% |
| Fixed/Variable, total products (all LTVs) | 5,087 | 2,258 | 5,264 | 5,385 | 4,995 |
| Data from Money comparer.nl are as of the first available day of the month, unless stated otherwise | |||||
My guess is we’re about halfway through the downturn from last September’s peak and the market will start to recover early next year. But a lot depends on the timing of that first rate cut. Once people can see through the rising costs of mortgages, confidence can begin to return. The underlying demand for housing remains high.
And that first rate cut? That, of course, depends on the rate at which inflation decreases. There was a glimmer of light in those numbers last week. Everyone was understandably focused on the fact that inflation is stuck at the consumer level. But at the wholesale level, it’s whizzing down.
The producer price index – what companies charge for what they sell – rose nearly 20 percent last July. That was terrifying, and it speaks well of our distribution system that inflation at the consumer level was not much more than half. Now the index is down to just 2.9 percent year-on-year and negative on a six-month basis. It will take a few more months before falling producer prices are reflected in the prices we pay in the shops.
I am also concerned about rising costs in the services sector, where staff shortages make life very difficult. But we are past the peak and the uncertainties are about how quickly inflation will decrease and where it will settle, not whether it will fall further.
If this is more or less correct, we can expect the first rate cut in the first half of next year – probably in February, when the Bank updates its forecasts in the quarterly Monetary Policy Report. However, that doesn’t mean the ultra-low rates of the past decade will return, certainly not for a generation. Maybe never.
Never? Well, that’s quite a long time, but pay attention to this. Until the end of 2011, the yield on 10-year gilts has not fallen below 2 percent at any time in the past 300 years. But for most of the next decade, it dipped below that, hitting a low of 0.074 percent in August 2020. That caused the cost of borrowing to go down for everyone. Now it is 4.3 percent again.
So what borrowers went through in that decade was quite unprecedented. Rates will drop slightly, but not to the level many homebuyers consider normal.