The modest signs of improvement in the UK economy, particularly in the housing market, over the last few months might have justified a small rise in gilt yields and swap rates but the upward surge in rates is almost entirely on the back of comments from Ben Bernanke, which the market has interpreted as meaning that rates in the US will start rising sooner than previously expected.
However, comments on Tuesday from Mervyn King to the Treasury Select Committee seem designed to dampen down this expectation on the basis that the UK still has major problems, as highlighted only last week by the PRA telling even Nationwide it needed to raise more capital, despite its balance sheet being much lower than the banks. With the regulator requiring lenders to have more capital this will continue to restrain their ability to lend and hence also limit the pace of economic recovery.
Likewise the rise in sovereign bond rates in the most exposed Eurozone countries, in particular Italy, where 10 year rates have risen by 1%, brings forward the timetable for the next stage of the Eurozone crisis.
Not only will many consumers struggle if interest rates increase too much too quickly but so will many countries because their sovereign debt has increased so massively over the last 5 years and even an extra 1% on the rates they have to pay to refinance maturing debt will significantly increase the pressure they are already under.
The authorities therefore need to stop longer term rates escalating much further to avoid the increased financial pressure this will cause to consumers and certain countries from curtailing what small signs of recovery are emerging in some economies. I suspect the market reaction to Ben Bernanke’s comments was much greater than he expected and central banks on both sides of the Atlantic are now trying to put the lid on the damage.
However, what it demonstrates very clearly is how quickly interest rates can move when the mood changes. Nevertheless UK Bank Rate still looks unlikely to rise before 2015 and Bank of England Deputy Governor Charles Bean reiterated today that the possibility of negative interest rates was still on the table, although not likely.
With the Bank of England trying to calm the markets the short term spike in swap rates has probably run its course but such a massive rise in rates must have some impact on the cost of fixed rate mortgages, especially those for 5 – 10 years. A few small lenders have increased some rates but so far none of the major lenders has.
On the plus side lenders have plenty of money to lend and access to more than most want from the Funding for Lending scheme. Competitive pressures will help to keep rates low but after such a big rise in swap rates it is difficult to see any significant further rate cuts. The only question is how many lenders will increase rates and by how much.
The risk/reward ratio is therefore in a no brainer situation for anyone looking for a fixed rate mortgage. The scope for rates to fall from current levels is negligible, whereas the scope for increases is significant. Markets may settle down and wholesale rates may ease back but they won’t fall back to the levels of 2 months ago.
The best case scenario for fixed rate mortgages is that the most competitive rates remain at current levels but a more likely outcome is that we will bounce off the new all time low just reached and the only question is when rates rise, by how much and how quickly. On that basis the message for consumers is that if you want a fixed rate mortgage there is nothing to be gained by waiting and a very real risk you will end up paying more if you do.
It is also another reason for choosing a longer term fix, say 5 or 10 years, on the basis that the premium compared to a two-year fix after factoring in fees is relatively small and a price well worth paying, subject to the longer lock in period being acceptable, as the increasingly volatile market highlights the risk that remortgaging in two years time might only be available at higher rates than are on offer today.
Ray Boulger is senior technical manager at John Charcol
