Consumer inflation has reached unprecedented levels since the beginning of 2022 (peaking at 11.1 per cent in the 12 months to October 2022) prompting the Bank of England (BoE) to aggressively increase its benchmark interest rate – the Bank of England base rate (BBR).
There have been 10 consecutive rises to the BBR, taking it from 0.1 per cent in December 2021 to four per cent as of February 2023, the highest rate in 14 years.
Swap rates have gradually increased since the beginning of 2022 with some significant jumps at times, which has naturally led to a sharp increase in mortgage costs, taking them from historic lows to levels not seen since the 2008 Global Financial Crisis.
Fixed mortgage rates tend to be more closely correlated to swap rates than base rates and mortgage lenders are constantly repricing their mortgage offer to reflect market conditions.
Since the outbreak of war in Ukraine, financial markets have been in turmoil and volatility has become a constant theme in the UK. With a very uncertain economic outlook, rates have generally been highly sensitive to political news and macroeconomic indicator releases.
Indeed, the ‘unfunded’ mini Budget announced last September by the government largely disrupted the markets causing swap rates to dramatically rocket, with two-year swap rates approaching six per cent, and mortgage rates to peak to their highs.
The swap rate rise and fall
Fortunately, swap rates have followed a downward trend since but are still high compared to 2021 and 2022 levels, causing mortgage rates to also remain elevated.
Currently, the two-year swap rate sits at around 4.1 per cent, the same level that the markets expect the BBR to be in 24 months. The pricing of a two-year fixed rate mortgage is calculated using the two-year swap rate plus a product margin which varies subject to the customer’s circumstances, property, and loan to value (LTV).
The sharp and sudden increase in swap rates after the mini Budget was detrimental to mortgage lenders as they were unable to immediately reprice their mortgage products.
This meant that while swap rates were at their highest point, lenders continued to offer their current range of mortgage products at a loss or a much-reduced margin. Once lenders were able to reprice, however, mortgage rates in the market were up to five times higher than they had been prior, in the case of a typical two-year fixed rate product offered by a high street lender.
Generally, inflation levels have been improving in the last few months and are expected to continue to fall this year. This will support a market view that the Bank of England may not raise rates by much further in the short-term, with the BBR likely reaching its terminal rate in the first half of 2023, leading to a gradual fall in swap rates across maturities.
While markets anticipate mortgage rates to continue decreasing this year from the highs of Q4 last year, we do not expect to see them return to the low levels to which we have become accustomed over the past decade.
Indeed, it is possible that the mortgage rates we are seeing now may in fact be the new norm for the foreseeable future.
