Speaking on a webinar hosted by Landbay, Philip Shaw, Investec’s group economist, reiterated that he expected the base rate to peak at four per cent but acknowledged that there had been a “massive range in market expectations” in a short period of time due to the mini Budget, with predictions going as high as six per cent.
He said that with the next Monetary Policy Committee meeting, which is under two weeks’ time, he expected a “large hike” of around 0.5 per cent, but not 0.75 per cent, which he said was a “one-off”.
Fixed rate dominance makes interest rate hike impact ‘difficult to predict’
Shaw said that with the “predominance of fixed rate mortgages” it made the “transmission mechanism of interest rates much more difficult to predict”. He said that this is how changes in interest rates feed through into the economy.
He said that within the outstanding stock of UK mortgages, 83 per cent are on fixed rate terms and that was a shift from 10 years ago when it was around the 28 per cent mark.
Shaw also noted that the number of households with a mortgage was around 30 per cent in the UK.
“So not only do you get probably a more delayed impact through interest rate changes than previously but also a smaller impact because you’ve got a smaller proportions of households with a mortgage. It makes it more difficult to predict.”
He said that it made it “more likely that authorities will overshoot with interest rate increases”, which he said that Bank of England was aware of.
“Central banks have been front loading interest rate increases. They’ve been saying that we really don’t want to go back to the 70s and risk a labour market explosion.
“If anything, we’ll err on the side of being more aggressive with interest rates in the short term and then if we need to cut rates, we will then cut rates. That’s the approach they’re taking. But even on that approach, we don’t think we’re going to get much more than one percentage point of rate increases in the UK between now and the peak,” Shaw explained.
‘Plenty of scope’ for mortgage pricing to reduce
Shaw said that if market expectations of bank rate increases were “overcooked”, by implication swap rates would come down as well so there is “plenty of scope” for mortgage rates to reduce further from current levels.
However, he added that it was also “absolutely feasible” for the bank rate to “move in different directions from mortgage rates”.
“Fixed term mortgage rates are all about interest rate expectations, and if expectations over the medium term are coming down, as we expect, it is very feasible and think likely that mortgage rates will come down from now,” he explained.
Labour market ‘biggest threat to medium-term inflation’ due to ‘wage spiral’
Shaw continued that the Bank of England regarded the labour market as the “biggest threat to medium-term inflation because of surging pay”.
He said in the past when inflation was in double digits, wage increases were also in double digits, but then firms would “pass on the higher labour costs in terms of high prices” and cause a “wage spiral”, which the Bank of England wanted to avoid.
Shaw noted that the unemployment level was around 3.6 per cent currently but could increase to around five per cent next year.
Shaw added that employment levels were about 300,000 below pre-pandemic levels, which was explained by a rise in inactivity of people of working age that are neither employed or unemployed.
The biggest factor for this increase was “long-term sickness” such as long Covid, he added.
“This is a real problem because we have labour shortages and one of the keys to solving one of our economic problems looking forward is to reduce that inactivity and increase labour supply at least from the domestic labour force.”
