Last month the Bank of England (BoE) raised rates for the first time since the global crisis in 2008/9. While the BoE chose to hike by only 25 basis points, some commentators feel that they could be embarking on the first tightening cycle in a decade. After the decision to raise was announced, BoE Head Mark Carney described a somewhat rosy economic picture that could allow Threadneedle Street to keep on pumping up interest rates.
For UK borrowers with variable rate mortgages, the notion that rates are headed higher is cause for concern. Mortgage interest rates will follow the BoE’s overnight rate higher, and this could mean much higher interest payments going forward.
Variable interest rate mortgages are generally cheaper up-front, but when rate rises hit, those early savings can be wiped out in a matter of a few year’s time. Locking in a fixed rate mortgage will give borrowers peace of mind, but remortgaging is time consuming. Fixed rate mortgages are also more expensive, so if the BoE is done tightening, this is no time to go rushing into a new mortgage.
The BoE is in a Tough Spot
Mark Carney’s post meeting speech may have been overly optimistic. According to a statement issued on the BoE’s website, the bank may be putting inflation before the possible economic headwinds the UK is facing.
“CPI inflation was 2.4% in June, pushed above the 2% target by external cost pressures resulting from the effects of sterling’s past depreciation and higher energy prices. The contribution of external pressures is projected to ease over the forecast period while the contribution of domestic cost pressures is expected to rise. Taking these influences together, and conditioned on the gently rising path of Bank Rate implied by current market yields, CPI inflation remains slightly above 2% through most of the forecast period, reaching the target in the third year.”
The statement does acknowledge that:
“The MPC continues to recognise that the economic outlook could be influenced significantly by the response of households, businesses and financial markets to developments related to the process of EU withdrawal,”
but this seems like something of an afterthought given the disruption that Brexit could cause.
Numerous events surrounding the UK’s exit from the EU are nearly certain to be inflationary, which could mean rising rates in the face of a broad-based economic slowdown in the UK. If this is the case, variable rate mortgage holders should consider locking in historically low rates while they still can.
Rates May Not be Going Any Higher
Outside of a higher-than-desired inflation print, and a tight labor market, the BoE has little reason to pursue an aggressive tightening campaign. The overall economic picture in the UK isn’t dire, but the upcoming exit from the EU is a potentially catastrophic near-term economic event.
Far from being gloom and doom, the medium-term outlook for a post-Brexit UK is positive. Over the next two years, the outlook is less attractive. Brexit will almost certainly cause a rise in prices, which is likely to choke off any increase in broad economic activity. It may even cause a short recession, which would be a major damper on any further tightening in monetary policy.
Housing prices are already out-of-reach for many in the UK, and the decades-long global housing boom is showing signs of falling apart. Despite the fact that interest rates have remained extremely low by historical standards, growth in both the UK and developed world remains sluggish.
In fact, Ian McCafferty, an outgoing member of the BoE’s monetary policy committee (MPC) said that borrowing rates in the UK will likely remain below 5% for the next two decades. While he did say that the BoE would probably have to continue to raise rates in the face of an extremely tight labor market, rates weren’t going to return to the historical norm anytime soon.
What is a Borrower to do?
Given the fact that the UK is facing major uncertainty surrounding Brexit, and the nation is still posting lukewarm growth figures, it is highly unlikely that the BoE will pursue an aggressive tightening campaign. The markets aren’t expecting any further action from the BoE in terms of rates at the next meeting, so borrowers have some time to weight their options.
Moving into a fixed-rate mortgage is a good way to stabilize your monthly expenses. If you live off fixed income, and are worried that the era of ultra-low interest rates is at an end, this could be a good time to start shopping for the best rates for a fixed-rate mortgage. There is also the chance that Brexit could force rates down again, which would give borrowers a change to remortgage at lower levels.
Featured Image: TLS