The Bank of England made the first cut to interest rates in four years in August 2024, giving hope to mortgage holders that the borrowing squeeze is coming to an end. Here we explore when rates could be cut.
The base rate rose from 0.1% to over 5% between December 2021 and August last year in an attempt to put the brakes on runaway inflation. As a result, CPI fell from its peak of 11.1% in October to 2.2% in July. Wage growth has also hit the lowest level in two years.
But with the news that the economy continues solid growth throughout the first half of the year, hopes that rates will tumble have been squashed.
TheBank of England’s base rate cut from 5.25% to 5% on 1 August was welcome relief for mortgage holders. If you have a fixed-rate mortgage deal coming to an end soon, or you’re on a standard variable rate or tracker mortgage, you’ll be keeping a keen eye on where it will head next and when.
Savers have a hard choice to make too, whether to hold on in a high-paying easy-access account or move to a lower-paying fixed-rate bond that will not be affected by any future rate cuts.
In this article, we cover:
- When will interest rates fall?
- Why have interest rates been rising?
- How do higher interest rates affect inflation and mortgages?
- What help is there for mortgage customers?
If you’re looking for a new mortgage deal, and want to see the kind of rates on offer, try our mortgage comparison tool*.
When will interest rates fall?
The Bank of England raises and lowers interest rates in an attempt to keep inflation as close to its 2% target as possible. Inflation spent two months at that target, before rising slightly to 2.2% in July.
However, crucially, the Bank’s rate-setting MPC knows changing rates now won’t change inflation for some time to come – as it takes time for changes to filter through to prices.
That means despite the slight rise in inflation this month, rates are still predicted to fall by the end of the year – although only to 4.75%. Analysis by research firm Capital Economics suggests that rates will hit 4% by the end of 2025.
The future of interest rates depends significantly on how quickly inflation drops and remains stable. Wage growth, unemployment and services inflation seen by many as the main indicators of when this will happen.
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Why have interest rates been rising?
Interest rates shot up in the UK between December 2021 and August 2023 as the Bank of England responded to runaway inflation.
The main factors pushing up the cost of living were rising energy and food prices and a shortage of workers, which led to higher wage costs for businesses. To afford these extra costs, many companies were forced to raise the price of the goods and services they offer.
One of the main roles of the Bank of England is to keep the annual CPI rate of inflation as close to 2% as it can. The Bank’s monetary policy committee’s main way of doing this is by raising (or cutting) interest rates.
Inflation has now fallen sharply from its 41-year-high of 11.1% in October 2022 to 2.2% in July. Where it heads next will have a big impact on where interest rates will go.
At its last meeting the Bank said inflation was projected to be 1.9% in two years’ time and 1.6% in three years.
But inflation is not the only measure that the Bank of England looks at when setting rates.
Why has the Bank of England cut the base rate to 5%?
Financial markets had priced in two rate cuts in 2024, the first predicted to come in the summer.
Inflation fell to its 2% target in June providing the evidence that the Bank of England wanted to see that price pressures are easing.
Bank governor Andrew Bailey – one of the five policymakers who voted to cut rates on 1 August – has said that inflationary pressures have “eased enough” to allow an easing of policy.
He also warned, as he has repeatedly done in recent months, that the Bank needs to make sure inflation stays low, and mustn’t cut rates too quickly.
A fortnight later, it was announced that the inflation measure for July rose slightly to 2.2%, underscoring the governor’s concerns that the path ahead might be bumpy.
How do higher interest rates affect mortgages?
Over recent years, mortgage rates have been following the trajectory of the rising base rate.
In the wake of the Banks first rate cut in four years in August, a number of big lenders have been cutting the rates on their fixed term deals.
Moves in rates immediately affect those taking out a new mortgage, rather than borrowers on a fixed rate or even tracker rate deal.
If you have a tracker rate mortgage you will see a change in your repayments the month after a move in interest rates. Those on a fixed rate deal will need to either wait for their deal to expire or pay extra to exit early if they want to take advantage of cheaper rates.
How do higher interest rates affect inflation?
When interest rates rise, the cost of borrowing money becomes more expensive. On the flip side, banks tend to offer better rates on savings accounts.
The hope in raising rates is that we will borrow less and save more. That takes money away from shops and services lowering demand. And if demand falls, prices should eventually fall too, thereby lowering inflation.
The Bank is particularly concerned about something called the wage-price spiral. Unemployment is low in the UK as businesses struggle to find workers to fill many vacant roles.
In this scenario, employees have more power to demand higher wages to keep up with the rising cost of living. To pay for a larger wage bills, businesses increase the price of their goods and services, keeping inflation higher for longer. Find out more about why wages are currently rising.
How much can raising interest rates affect inflation?
There is only so much that the Bank of England can do to influence inflation, especially given the reason it rose so much back in 2021.
For example, there is nothing the central bank could do about pandemic supply shortages, wars or droughts. But it can try to affect wages and consumer spending in the UK – as well as the pound’s exchange rate. Nevertheless, the sustained and aggressive interest rate hikes appear to be a significant factor in bringing down inflation.
How are higher mortgage rates affecting you? Let us know: questions@timesmoneymentor.co.uk
How could higher interest rates affect the housing market?
Chancellor of the ExchequerRachelReeves welcomed the Bank’s decision to cut the base rate to 5% but also highlighted that mortgage rates are still much higher than two years ago: “Millions of families are still facing higher mortgage rates after the mini-budget.”
The average two-year fixed mortgage rate is currently 5.75%, according to MoneyfactsCompare. It has come down substantially from a high of 6.86% in July 2023 but is a long way from the 2.17% it was in June 2021.
The leap in mortgage rates means many millions of homeowners face far higher monthly costs. The fixed-rate deals of 1.6 million households will come to an end in 2024 and nearly all of them will see an increase in monthly repayments.
Bank of England figures show a typical mortgage borrower coming off a fixed rate will see monthly mortgage payments rise by about £240, or 39%. That adds up to a £2,880 rise in mortgage payments over a year.
These significant added costs may force some mortgage holders to sell their homes. We’re already seeing more mortgage holders fall behind – the latest figures from banking association UK Finance show the number of people in arrears and repossession rose in the first three months of the year.
It’s also more difficult for prospective first-time buyers to get on the housing ladder, as the heightened mortgage costs make affordability checks tougher to pass.
“Based on our current economic assumptions, we anticipate a gradual rather than a precipitous decline in house prices,” said Kim Kinnaird of Lloyds Bank.
House prices falling across the board could mean millions of households end up in the choppy waters of negative equity.
Read more: What’s happening to house prices?
What help is there for mortgage customers?
The government has spoken to mortgage lenders, and instructed them to provide greater support for their mortgage customers. Customers can temporarily switch to interest-only payment plans for up to six months while interest rates stabilise. This will not affect on their credit score.
However, it’s worth noting that if you take this step, you won’t be clearing your mortgage balance for the duration of this period. Your mortgage will therefore end up being more expensive in the long run.
Some homeowners or those that have bought a shared ownership property may also qualify for Support for Mortgage Interest (SMI). This is a government loan that goes towards the interest on your mortgage repayments or loans that you have taken out for certain home repairs and improvements, up to £200,000.
You will need to repay the loan with interest when you sell or transfer ownership of your home (unless you’removing the loan to another property). The interest rate used to calculate the amount ofSMIyou’ll get is currently 3.16%.
To be eligible, you need to be in receipt of a government benefit such as Universal Credit or Pension Credit.
Our consumer rights expert explains your options if you’re struggling to make mortgage repayments.
What’s happening to savings rates?
Savings rates tend to follow the trend of interest rates in real time, as well as reflecting predictions for the future.
Easy access rates react roughly in line with the Bank of England’s base rate, while fixed-rate savings accounts tend to follow predictions of where rates will be over their term.
With interest rates being held at the same level by the Bank of England and expectations that the next movements will be down, savings rates – especially on new fixed-rate accounts – have been falling.
Check out the top interest rates on savings accounts at the moment.
How do ‘higher for longer’ interest rates affect investments?
High interest rates for a long period of time are not good for the value of most of your investments. It reduces the amount of money flowing through the financial system that can find its way into investable assets. This weighs down prices by reducing overall demand in the market.
The impact is compounded because people expect asset prices to be held down as rates go up. This means they sell off some of their existing investments, or stop buying new assets.
Higher interest rates also tend to translate to higher returns on savings accounts. This can make investing in stocks, or other assets that carry risk, seem less attractive on a relative basis than when rates are low.
Central banks are aware of the impact higher rates have on investments. In fact they intend it to be the case.
By holding down the value of assets they reduce the amount of money people have and this causes them to cut back on discretionary spending. This in turn helps reduce inflation, which is the central goal of raising interest rates in the first place.
Read more: How do interest rates affect the stock market?
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