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This is a question many borrowers are asking at the moment. Despite the base rate increasing by 50 basis points to 4% last week, several lenders have decreased their fixed rates since and continue to do so this week.
For tracker rates this is a different story. This increase in the base rate will place tracker rates above some fixed rate products for the first time since the mini-budget.
Mortgage rates and the base rate are not directly linked.
Firstly, let’s clear up a common misunderstanding. Mortgage rates and the base rate are not directly linked. Mortgage rates are determined by many factors.
While there is a myriad of factors which determine mortgage pricing, the three main factors underpinning mortgage pricing at the moment are:
The first two points speak for themselves especially since all lenders have had new targets in January and are now trying to lend as much as they can at a competitive price in order to deliver those targets in 2023.
5-Year Sonia Swap Rates
So as we all know, the Bank of England Monetary Policy Committee increased the base rate by 50 basis points last week to 4%, which was in line with market expectations and deemed the right step to control inflation.
Contrary to past activity, mortgage rates continued to fall following the base rate rise.
The reasons for this are because the rise was in line with market expectations and markets believe that the Monetary Policy Committee are doing the right thing to cool inflation. This is also evident by the current 5-year SONIA swap rate which are at the lowest they have been since the mini-budget fiasco last year. The current 5-year SONIA swap rate decreased from around 3.8% to 3.5% over the last month.
The Bank of England now expects inflation to have reached its peak globally across many advanced economies, including the UK. Following the latest base rate rise, the BoE chief economist Huw Pill mentions it is important they did not raise borrowing costs too high and hinted this might be the last rate rise for the time being (Sky News).
So, what are swap rates and how do they impact mortgage rates?
Swap rates reflect market expectations of the future direction of Central Bank interest rates. They are based on the assumption surrounding what interest rates are expected to be over the term of the swap rate. For example, a 5-year swap rate is the average expectation of interest rates over the next 5 years.
These assumptions consider factors like inflation, prices of food, fuel, and the general economy which all feed into these forecasts. This is also the rate at which lenders use when setting a price to borrow funds to assist with their own supply and demand. These rates only influence fixed rate mortgages: The higher the swap rate, the higher the mortgage rate before risk and lending appetite are considered.
Lenders use swap rates to protect themselves from interest rate risks and allow lenders to hedge the risk by locking in margins. By ‘locking in’, lenders maintain their margins even if the cost of funds increase, for example an increase in the base rate. Not every bank will choose to hedge using swap rates, some may choose to hedge naturally using saving bonds.
At the end of September 2022, 5-year SONIA swaps were being priced around 5.5% (the highest level on record). Today, this rate sits much lower at 3.5%*. The reduction in swap rates means that getting a 5-year fixed rate mortgage should be significantly cheaper than in the months leading up to now. Let us remember that back in October 2022 we were talking about a 5-year fixed rates at around 6.5% while now they have dropped to around 4%.
Can we expect mortgage rates to continue to fall?
The expectations for mortgage rates are positive as not only are swaps edging down but the cost of fuel is also decreasing and annual CPI inflation is expected to fall to around 4% towards the end of this year (MPC, 2023).
A further rise in the base rate last week should see inflation drop further which will help to keep this moving in the same direction.
This government pledge is to halve inflation in 2023.
The reduction in the swaps is showing increasing confidence in a reduction in rates, over a five year period and therefore we could see base rate reductions as the year goes on.
If you’re coming to the end of your current mortgage deal or taking out a new mortgage, we can help you understand your options, taking into account your individual circumstances, deposit, monthly mortgage repayments, and help you make informed financial decisions.
Call us today on 0800 980 877 or email us.
Please remember that your home may be repossessed if you do not keep up repayments on your mortgage.
*SONIA SWAPS correct on 08/02/23.