Interest Rates

20 June 2007

As we approach the next monetary policy committee (MPC) meeting there is no doubt that concerns will be raised as to the future of interest rates as I laid out in my article a couple of weeks back. I don’t believe they will raise rates now and it’s likely they will allow the current rate rises to have their impact on the spending patterns of the consumer, before making the decision to increase. Keep a close eye on the inflation data coming through over the next few months.

It dawned on me as I read the MPC notes there was potential for considerable alarm for many borrowers. The committee had commented in their notes that the interest rate rises had not really had their impact on spending yet and naturally that would be confusing. How do you take money out of the consumers pocket yet they carry on regardless.

It transpires that the rises in interest rates were not making their way through to the overall cost of borrowing. How could that be so? The average mortgage rate had only increased by about half the increases in the bank lending rate that had occurred since mid 2006. The reason for this was that over 50% of borrowers had a fixed rate mortgage. Whilst loan approvals, site visitors and unsecured lending (like credit cards) had continued to slow, other secured lending had continued to rise.

The concerns are high for those on fixed rates from two years ago. If they were fixing at say, 4.75%, a £120,000 mortgage would be costing them £475 per month. If their fixed rate finishes today, they will be coming out of that rate and onto a standard variable rate which is 7.39% so their new payment is a massive £739 per month. This is £264 more than they will have been paying - a whopping 56% increase in payments!

Worse news may be on the way. The concerns over spending were such that the financial markets have priced a further rise into the market before the end of the year taking payments up a further £25, or 61% more than they were paying in their fixed rate.

The impact could be considerable. Those who purchased on a buy to let mortgage at a fixed rate, expecting the rent to pay the loan, will now be wondering what to do. We have already started to see properties being sold as the rent does not cover the loan. Be careful if you are considering this as you may have capital gains tax to pay on disposal of the house.

It is very natural to expect that when these rises have their true effect (i.e. everyone comes out of fixed rates and has to pay more) that demand will slow. If demand slows and supply increases (i.e. people reducing their debt or risk by selling their 2nd properties) the inevitable will surely happen – falling house prices.

So what can you do? Well firstly consider where you think interest rates will go. If you think they will continue to rise you might take a fixed rate. If you thought they would fall, you might opt for a tracker or discounted rate.

The governor of the bank of England wrote to the chancellor of the exchequer to explain why inflation had risen over the maximum target of 3%. The comment was made that the committees’ central expectation was that inflation would fall to the target of 2% by the end of the year. If this is so, interest rates will prove benign and should then fall off, along with fixed rates.

If you are coming out of a fixed rate now, avoid fixing your new mortgage for too long, as rates should drop. This assumes you can afford that gamble. Personally I would wait to the end of the year before I fixed, to ensure the best deal. 


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