The Bank of England’s Monetary Policy Committee voted to raise interest rates in November for the first time in 10 years. The Bank rate is now 0.5%, back to where it was before the UK voted to leave the EU in the referendum in June 2016.
Having such low interest rates for such a long time is odd for the UK. In the 1980’s the average rate was 11.5%, while since 2010 the average has been less than half a percent. Even if such a low rate of interest is strange for the UK in a historic context, this rise is definitely not the start of a consistent and frequent increase in rates to the levels of earlier decades.
The Bank of England has based its latest forecasts on the assumption that there will be only two more 0.25% increases in rates over the next two years. And the financial markets pretty much agree. The markets don’t expect rates to get above 1.25 within five years.
The rise in rates will make very little difference to the housing market. Mortgage rates are already historically low and while some of the increase in bank rate may be passed on to new and existing borrowers there are two crucial factors that will limit any negative effect.
The first is that competition for mortgage business is still fierce, which will prevent mortgage rates drifting up sharply. Attractive deals will still be available. Allied to this is the expectation that most mortgage lenders will not pass on the whole increase in their savings rates. That means that the cost of funding will not rise as much, allowing lenders to widen margins, but also giving room to compete.
The second is that two thirds of all mortgages are on a fixed rate and will face no change in rates. Even those coming to the end of fixed rate deals will often face lower payments on new deals than they had been paying. That will limit the likelihood of any increase in payment problems or forced sales which could otherwise impact price growth and activity in the market. Furthermore, new borrowers already have to satisfy lenders that they can tolerate a rise in mortgage rates to c7%, significantly beyond the current offered rate even if the whole 25bp rise is passed on. The overall effect of the rate rise on affordability – of new or existing loans – is therefore minimal.
That is really good news for people wishing to buy property now. Even though the latest generation of first time buyers have no knowledge of the risks of rising interest rates on mortgage payments, buyers are well protected by the affordability tests they had to pass to qualify.
On top of that, they can budget in the knowledge that interest rates will remain low for some time to come, keeping their mortgage payments manageable. And if our forecasts are correct, wages will begin to increase faster than inflation in 2018. That will improve the standard of living of households, in turn helping to boost economic and housing market sentiment. While this is unlikely to cause the rate of activity to increase sharply, it will help to set the foundations for the market to gradually begin to return to normality.