Interest rates could reach 2.5% by the end of 2027, one economist predicts: what would that mean for mortgages?

An influential economic research firm predicts that interest rates will fall to 2.5 percent by the end of 2027, a much larger drop than the market consensus of 3.75 percent.

Economists at Oxford Economics believe that the Bank of England will cut interest rates much further than financial markets are currently predicting.

The market forecast is that interest rates will fall to 3.75 percent by the end of 2025, before settling around that level and becoming the new normal.

However, Oxford Economics believes the downward momentum will continue in 2026 and 2027, with interest rates reaching around 2.5 percent.

Andrew Goodwin, chief UK economist at Oxford Economics, says the difference is partly due to financial markets expecting higher inflation than is currently the case, but also partly due to demographic changes.

“In the longer term, interest rate levels are usually determined by structural factors, such as demographic developments and productivity growth,” says Goodwin.

“Before the pandemic, interest rates were very low, largely because the population was aging and productivity growth was very weak.

‘Once the period of high inflation is over, we expect these structural factors to reassert themselves.

‘The consequences of demographic developments over the next ten years are likely to be similar to those in the pre-pandemic period, especially as the state pension age will only increase by one year.

‘And while we think developments such as AI will provide some support, we think productivity growth is unlikely to return to the much stronger figures Britain achieved before the global financial crisis.’

The latest projection from Oxford Economics is slightly more cautious than last year. Just a few months ago it was suggested that interest rates would eventually fall to 2 percent in 2027.

According to the report, the recent change to UK fiscal rules in Labour’s October budget suggests that policy will be looser in future.

She also expects the new US policy landscape to lead to higher, more volatile inflation around the world, putting slightly more upward pressure on rates.

What would this mean for mortgage interest rates?

If Oxford Economics’ forecast comes true and interest rates reach 2.5 percent at the end of 2027, what would happen to mortgage costs?

The fixed mortgage rate is determined by the swap rate, and not by the central bank’s base rate.

Swap rates reflect the market’s expectations of future interest rates and play a crucial role in how lenders price fixed mortgage products.

Currently, fixed-rate mortgages have priced in a future drop in interest rates, but it is not as large as the magnitude predicted by Oxford Economics.

If the 2.5 percent prediction turns out to be correct, it could have significant implications for fixed-rate mortgages, said Nicholas Mendes, mortgage technical manager at broker John Charcol.

“Fixed mortgage rates are typically priced at a margin above the swap rate, which reflects the lender’s costs, risk considerations and profit,” he says.

‘If the swap rate adjusts to a base interest rate environment of 2.5 percent, the fixed mortgage rate would probably fall below 3 percent.

‘However, individual circumstances, wider market conditions and lenders’ policies will all influence the exact rates available.’

Mendes thinks lenders’ appetites will also play an important role in determining the price of fixed mortgage rates in the future.

“As the market stabilizes, consumer confidence typically returns, pushing up real estate prices,” Mendes added.

‘In a more stable market, lenders’ attitudes towards pricing may change compared to trends seen over the past two years.

‘During this period, the market was challenging, with lenders competing aggressively for business in a stagnant environment characterized by lower levels of mortgage applications.

“Going forward, while lenders will still try to attract borrowers, the extent to which they are willing to reduce margins may change.

“It will be interesting to see how lenders balance their appetite for business with maintaining margins in a more stable environment going forward.”

However, Oxford Economics’ Andrew Goodwin thinks mortgage interest rates won’t fall anytime soon.

“A lower Bank of England policy rate should eventually translate into lower mortgage rates for British homeowners, but not yet,” Goodwin said.

‘The financial markets think that bank rates will settle at a much higher level than Oxford Economics expects, and – if we are right – it will probably take some time for the markets to adjust to our way of thinking.

“It will probably take a few more years before mortgage rates fall below 4 percent again.”