I met someone today who was worried that interest rates were about to rise and push up the cost of her mortgage. She is not alone; over a third of people expect interest rates to rise this year, according to the Bank of England’s November Inflation Attitudes Survey
On the face of it, that is surprising – and important.
What happens when we expect rates to rise?
Way back in 2004, house prices paused for almost six months. Prices fell a little in the third quarter of that year and stayed there for the rest of the year. You can see GSPC’s prices data in our stats file. But it was only a pause. Shortly thereafter, prices resumed their upward trajectory.
So why did prices come to a halt then?
It was almost certainly the direct result of four successive increases in the Bank of England base rate which rose from 3.75% in November 2003 to 4.75% in August 2004. I remember agents reporting a sharp and sudden decline in enquiries from buyers at the time.
Even so, an official base rate of 4.75% was not high by historical standards and the one per cent increase wasn’t enough to make mortgages suddenly unaffordable. Mortgage repayments as a proportion of income were below the long term trend rate. The point is that it was the direction of rates, rather than their actual level, which was what mattered. Once it became clear that rates would go no higher, the market quickly recovered momentum.
So, buyers are influenced by expected future changes in interest rates as much as by the current rate. That makes perfect sense and suggests that we are more canny than many regulators assume.
But, if a third of people genuinely believe that rates are on the way up, that is likely to have an effect on activity in the property market that does not seem to be warranted by the circumstances. Is it time for the Bank of England to give better guidance on the future path of interest rates?
Time for more certainty on rates?
It is not as if the idea is entirely novel. The Federal Reserve in the USA has said that it will keep official rates ultra-low (currently 0.25%) until unemployment falls to 6.5% (from the current 7.9%). That tells the markets that official rates are likely to remain low for years.
And it’s not likely that the Bank of England is going to raise rates any time soon. Citi Bank recently predicted that base rates in the UK would stay at 0.5% until mid-2017 – that’s around four and a half years away.
Elsewhere, the central banks of the major developed economies are either under pressure to reduce rates further (e.g. The European Central Bank) or are expected to keep ultra-low interest rates in place for years to come (e.g. Japan).
In short, a rise in base rates may be years away. And when they do start to rise, the Bank knows that high personal indebtedness in the UK means that even a small increase will have a significant impact. It will want to avoid pushing the country into a renewed recession by raising rates too fast.
Given the inhibiting effect of expectations of higher official interest rates in the short term, there is a strong case for the Bank of England to follow the lead set by the Fed and make it clear that rates will be low for years to come.
Will mortgages rates follow?
The interest rate paid by homeowners is now less closely related to the Bank of England base rate than it once was. Mortgages rates rose last summer – despite no change in the base rate – because a possible collapse of the Eurozone meant banks wanted to hold on to cash in case they had to cover losses.
Since then, however, the Euro crisis has abated (even if it has not disappeared) and the Funding for Lending scheme launched by the Bank has provided cheap money to lenders provided they pass it on. The overall effect has been to reduce the cost of mortgages and to increase the number available.
Of course, it is possible that a revival of the Euro crisis will push up interest rates to consumers once again, but the more likely scenario is a long period of low interest rates followed some time from now with a very gradual increase in small increments.