Speaking at an event earlier today, Philip Shaw, Investec’s group economist, said: “It’s fairly clear that the job is not done, we think that rates will probably get to four per cent early next year, then the Bank of England will say that’s enough and then we will wait and see.”
He said he thought that markets were pricing in a peak of around 4.5 per cent. He noted that this was lower than post-mini Budget when peak base rate expectations were around the six to 6.25 per cent mark.
Shaw said that towards the end of next year inflation could start to fall, pointing to energy prices coming down and a loosening of the labour market, which could then mean interest rate reductions.
“We’re crossing our fingers that we get interest rate reductions by the end of next year to the 3.25 to 3.5 per cent level and some further cuts through 2024.”
“In the meantime, we’re still in a rising rate environment, the Bank of England is actually saying quite stridently that we don’t think that rates will rise as far as markets were pricing in when it compiled its forecasts at end of October, early November.
“They were signalling rates at 5.25 per cent at that stage, so somewhere around four per cent I think is reasonable.”
Shaw continued that interest rate expectations were important for mortgage pricing as it was based on swap rates, which are predicated on where the markets think interest rates will be in the coming years. He said that these had been slowly falling in recent weeks as markets prices in a lower series of medium-term interest rate expectations.
Swap rates are when two parties swap interest rate payments for another. One party agrees to receive a fixed-rate payment, while the other receives a variable payment.
For mortgages, it is what lenders pay financial institutions to secure fixed funding for a set period of time. They come in a number of terms and is used to price mortgage products.
Following the mini Budget, swap rates increased rapidly, with up to 100 basis point increases in a day for two-year swaps. Typical increases over the past few months have been in the five to 10 basis point category.
“Our expectation is that although short term [bank base] rate will rise, what we’ll see is those increases in the bank rate not matching market expectations and swap rates continuing to come down.
“I’m pretty hopeful that at the moment, actually the gap or spread between swap rates and average mortgage rates is quite high so there may be scope for some lenders to push their rates down.”
House prices could fall between five and 10 per cent but no crash
Shaw forecasted a fall in house prices of five to 10 per cent from peak to trough with “no house price rally at any point quickly”.
However, he said that since March 2020 house prices have increased by nearly 25 per cent, which he attributed to lower interest rates, stamp duty holiday and factors like the furlough scheme preventing an economic crash.
He also noted that rising mortgage rates did not necessarily equal a crash in house prices.
Shaw noted that if interest payments doubled it did not mean that the mortgage outlay has doubled as most mortgages are repayment mortgages. He also said that “affordability changes all the time” so there is “no direct read through to house prices”.
“You might get mortgage rates sticking at 5.5 per cent, I suspect they will come down, but people will still buy houses it will just be fewer people.”
He noted that typically during difficult economic periods house prices don’t collapse, but volumes fall back.
“A period of modest correction seems the most likely situation.”
