If interest rates fall, could the 3 per cent mortgage make a comeback?

Independent

11 hours ago

Andrew Bailey, governor of the Bank of England, created a flurry of excitement when, in an interview with The Times, he said that interest rates could fall faster than anyone expected.
'I really do believe the path (of base rates) is downward,' he said, while hinting the 'cautious' and 'gradual' approach to cutting rates could change if there is enough 'slack' in the economy. This means resources going unused: factories standing idle, workers doing the same as a result of unemployment.
That slack is opening up. Employers warned that chancellor Rachel Reeves' decision to tax jobs by raising employer national insurance contributions (NICs) would have consequences. Workers are now grappling with them: wage settlements have started to decline while jobs are being axed.
If this does lead to faster rate cuts, it would ease some of the pressure facing employers and employees alike. A quarter point interest rate cut now looks nailed on when the rate setting monetary policy committee (MPC) meets at the beginning of next month, even with inflation expected to show an increase when the official data for June is released this week.
Businesses, particularly smaller ones, desperately need the cheaper financing costs this should usher in. However, what really matters to (most) mortgage holders – those on fixed rate deals – is what happens to the longer term pathway taken by rates, which governs the City's interest rate swaps market. This is where banks obtain their financing for the most popular fixed rate mortgage products.
Prices have been falling in anticipation of lower rates. Per Moneyfacts latest averages, the typical two year fix stands at 5.05 per cent, compared to 5.48 per cent in January. The average five year fix has eased from 5.25 per cent in January to 5.03 per cent today.
If the swaps market takes Bailey at his word and decides that rates will indeed fall faster, better mortgage deals will follow. The currency markets have already taken action, with the pound losing ground against both the euro and the dollar in anticipation of UK rate cuts.
How much lower could mortgage rates go? It is already possible to find sub-4 per cent home loans for borrowers whose outstanding balances are relatively small when compared to the value of their homes. MoneySavingExpert lists several, basing its list on a loan of £200,000 for a property valued at £280,000, which is a shade above the average UK house price.
Does this mean we could see the 3 per cent level tested in future?
Don't send out the party invitations just yet. Nick Mendes, from broker John Charcol, is concerned that 'broader macroeconomic and political factors will keep mortgage rates elevated and above the 3 per cent mark'. He cites the global uncertainty created by the policymaking of Donald Trump – yes him again – and the domestic uncertainty caused by the UK government's apparent addiction to U-turns.
'My view is that we're more likely to see the base rate settle around 3.25-3.5 per cent and with swaps pricing in these expectations, I don't see mortgage rates falling below 3 per cent in the foreseeable future,' he says.
Richard Watkins, from financial advisor Continuum, is similarly minded. 'Lenders will not necessarily follow (the Bank of England) due to the state of the economy. This may increase mortgage default rates,' he warns.
Still, Moneyfacts sees signs of increasing competition among lenders. Its consumer expert Adam French says: 'A mortgage price war may be brewing as many lenders appear to be lightly pushing the accelerator pedal on the steady pace at which they have been cutting rates so far this year. Swap rates have also been falling steadily since early June, so we may see rates drop further in the coming weeks."
Much depends on what the MPC does next, and the signposts it offers in the accompanying minutes, which traders watch closely. For the record, I don't think the committee countenance a half point cut at this stage but it could signal more quarter point cuts than the two that the markets currently expect.
Complicating matters is the divided nature of the committee. When rates were on the floor, there was a long period of unanimous votes. That has changed. There have even been a couple of three way splits in recent times.
The hawks remain deeply concerned about the UK's above target inflation, taking the view that it is still too high to warrant reducing the interest rate stranglehold, even if it is squeezing the life out an economy which faces grave domestic challenges (from Reeves' tax increases) and arguably even greater problems hailing from abroad.
The doves, however, think rates need to come down harder and faster to prevent the economy from executing a swan dive, in which inflation sinks below the target for a protected spell.
The majority sit between the two extremes, favouring the governor's oft repeated 'cautious' and 'gradual' approach to reducing rates. However, if the labour market gets significantly softer, it could push members of the majority group, including Bailey, into the dovish camp.
This might not be enough to see the return of the 3 per cent mortgage. But it could still make life a lot easier for borrowers. Watch the labour market data like a hawk: it could release the doves.