Volatile Mortgage Rates hurt the Housing Market

Buyers and sellers had to process a series of different numbers starting with five last week.

The crucial number was 5.7%. That was the annual rise in services inflation reported last week, which was higher than the expected reading of 5.5%.

Stubborn cost-of-living pressures explain why the Bank of England felt unable to cut the base rate from its current level of 5.25% to 5% the following day.

It is also the reason the average two-year fixed-rate mortgage (75% loan-to-value) was 5.19% in May, according to the Bank of England.

In simple terms, if more of these figures started with four, demand in the UK housing market would be notably stronger.

When can we expect that to happen?

Services inflation is unlikely to fall below 5% until early next year, said Savvas Savouri, chief economist at QuantMetriks.

“It’s slowly drifting down but political events may force the Bank of England’s hand anyway,” he said. 

“If there is volatility after the US election in November, the pound could strengthen against the US dollar and the disinflationary impact means the Bank may lower more quickly. On the other hand, if a new Labour government in the UK sounds too inflationary, that will prevent the Bank from acting.”

Money markets were pricing in two cuts of 0.25% by January after the Bank of England’s decision to hold last week, although December also looked plausible. It means a higher percentage of mortgages should start with a 4 in the final quarter of the year.

Not that last week’s UK inflation numbers moved the dial particularly. The five-year swap rate was trading largely unchanged at around 4.1% last Thursday afternoon, having fallen from highs above 4.4% during the previous week thanks to weaker US inflation signals.

An added frustration for buyers or anyone re-mortgaging is how mortgage rates currently fluctuate so frequently in response to fresh economic news.

“The average margin for a mortgage lender is 0.3 percentage points but it used to be 1 or 1.5, which shows you just how competitive pricing is at the moment and how much they are trying to stimulate the market,” said Simon Gammon, head of Knight Frank Finance.

“The small margins explain why we are seeing more frequent re-pricing when swap rates move. It also means the main lenders are unusually close to one another in terms of their rates, so they will tend to cut and increase in order to control the flow of business. We aren’t seeing big rate changes but the frequency of the fluctuations at the moment means it’s exceptionally important for borrowers to keep an eye on the market.”

It's certainly not going to be easy for anyone guessing the trajectory of the UK housing market.

To recap, inflation and employment data on both sides of the Atlantic will have a strong bearing, as well as any inflationary signals from a new UK government or political volatility around the US election. Global appetite for the UK may also be shaped by political and economic events in mainland Europe.

• Tom Bill is head of residential research at Knight Frank *