Where will interest rates be over the next five years and what does it mean for the mortgage industry?
Tackling the issue in this week’s Market Watch are:
Barry Naisbitt, chief economist at Santander
“Prediction is very difficult, especially about the future”. That’s what Nobel Prize-winning physicist Niels Bohr had to say over half a century ago.
I imagine that after the economic events of the past few years he would have been even more convinced of his view.
Let’s go back just five years. In March 2006, house prices were 6.2% up on a year earlier and house price growth was headed towards double digits. There were 116,000 house purchase mortgages approved and 100,000 remortgage approvals. Bank rate was 4.50% and set to rise later in the year.
Back then, I suspect that no one would have predicted that, five years later and after the deepest post-war recession, house prices would be lower, the level of market loan activity – for purchase and remortgage – would have more than halved and policy interest rates would have been pegged at all-time lows for two whole years.
Times have certainly changed for both the economy and the mortgage market.
Given the extent of that change over the past five years, it is a tall order to look forward a further five with any degree of confidence.
We are, however, seeing economic recovery and, possibly in the next couple of months, policy rates will be raised from their emergency levels. They will still be close to all-time lows, though.
With public and private sector debt at exceptionally high levels, the next few years are likely to be dominated by a deleveraging story rather than gearing-up. It seems logical to expect mortgage borrowing growth to remain a lot slower than over the past decade.
Unless inflation gains a foothold – and there are mixed views on that – this process is likely to mean that rates will rise only gradually and that, with the economy growing again, there will be moderate increases in the number of people seeking to borrow, at the same time as rates are gradually rising.
With these forces at play, a re-run of the mortgage market expansion that we saw about five years ago looks unlikely, but what Niels Bohr said remains as a caution.
Fionnuala Earley, UK consumer economist at RBS and NatWest
With interest rates at a record low of 0.5%, it’s clear that the only way for them to go over the next few years is up.
This is what you would naturally expect, if you think the economy is going to recover. We think that it will, albeit in a slow grinding way, and so expect rates will begin to rise from the third quarter of this year, reaching 3% by the end of 2012.
Of course, there are a lot of uncertainties, not least because of stubbornly high inflation and rising oil prices.
This expands the range of possibilities, even in the short term. The further into the future you go, the more uncertain things become. Who could have predicted the tragedy in Japan for example?
Our central view is that rates will settle at about 4.5% by 2015 – in line with the average since the Bank of England took responsibility for interest rates in 1997.
If rates move in line with our central view, there wouldn’t be any nasty surprises for the mortgage industry.
In fact, with a growing economy and rising employment, most existing borrowers should find their financial conditions sufficiently improved to manage the rise in payments.
For new buyers and movers, stronger economic growth and greater confidence in the future should mean that housing transactions will pick up and house prices will rise modestly, increasing the demand for mortgage finance.
However, we should not be naive about the lasting effect of the financial crisis.
It is likely to be some time before very high percentage loans become readily available and the FSA’s proposed rules around affordability could mean that mortgage loans will be tougher to secure than before the crisis.
Howard Archer, chief European and UK economist at IHS Global Insight
Major uncertainty exists over just how soon the Bank of England will start hiking Bank rate and how quickly it will then rise.
March 2011 saw Bank rate celebrate a second birthday at the record low level of 0.50%, but the Monetary Policy Committee is now deeply split over how soon to raise interest rates.
Whether or not the Bank of England hikes interest rates in the second quarter will depend critically on how well the economy performs over the coming weeks, as fiscal tightening really kicks in.
The unexpected contraction in GDP in the fourth quarter of 2010 has raised concerns and uncertainties over the underlying strength of the economy and its ability to withstand the increasing fiscal squeeze.
At the same time though, consumer price inflation of 4.0% in January is double the 2.0% target level, leading to significant concerns that higher inflation could become embedded.
Even if interest rates do rise in the near term, the probability remains that they will move up relatively gradually and stay very low compared to past norms.
Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze.
In addition, we do believe that inflation will fall back markedly later on in 2011 and during 2012 as relatively modest, below-trend growth and elevated unemployment limits underlying inflationary pressures.
Although wage increases are showing some signs of rising modestly, the increases are generally limited and seem likely to remain so given high unemployment. This means households’ purchasing power will continue to be squeezed markedly.
Specifically, we currently expect Bank rate to only rise to 1.00% by the end of 2011 and to 2.00% by the end of 2012.
Furthermore, with the fiscal squeeze planned to last throughout the duration of this parliament, we believe that interest rates will only rise gradually thereafter, reaching 4.00% in 2014 and peaking around 4.50% in 2016.