Why are mortgage rates so much lower than the BoE Base Rate?

A slew of lenders have introduced sub-4% mortgage interest rates in recent weeks. More followed suit after the Bank of England announced its 0.25% cut to the Base Rate earlier this month.

But, following that, the ONS reported an uptick in inflation (from 2.0% to 2.2%), showing just how volatile and vulnerable the economy is.

Does this mean that lenders began reducing their mortgage interest rates prematurely?

From the evidence available to us: no, not really.

Whilst inflation is on an upward trajectory, swap rates are not. This may mean any further cuts to the BoE Base Rate are delayed.

But that doesn't necessarily mean interest rates will mirror the Base Rate in its stasis.

Today, we look at why this goes against the grain.

More importantly, we consider short-term factors affecting mortgage interest rates and options for homeowners still holding out for better rates.

Why a small rise in interest rates may yet have serious implications

July's uptick was the first time inflation had risen in six months. And, even though the market anticipated the rise (largely due to energy prices*), it rose more than expected.

0.2% may seem like a small increase. But it's sparked a flutter of uncertainty about future Base Rate cuts.

Since 2020, the Bank of England had resolutely maintained its Base Rate of borrowing at 5.25%, predominantly to curb inflation. But it cut that rate in August, much to the relief of homeowners nationwide.

But, what do you know: inflation then went and bounced back up?!

Predictable, you ask? Maybe. And that's why this latest inflation data might complicate the Bank's future decisions.

*One factor in this month's rise was the comparison to last year's gas and electricity prices. Whilst food prices also contributed to the rise, there is a silver lining. Core services inflation fell more than expected, which may help mitigate the rise in headline inflation's impact moving forward.

Impact of increased inflation on mortgage interest rates

The relationship between inflation and interest rates isn't always direct or immediate. The BoE's Monetary Policy Committee will be aware of the rise in inflation's connotations, especially in the short term. But that's not all.

Wage growth and unemployment figures

Other economic factors, such as employment rates and wage growth, also influence the Bank of England's decisions.

Despite ups and downs over the last twelve months, the latest quarterly figure, 4.2%, APR-JUN 2024, is the same as the same period in 2023. And wage growth, adjusted for inflation, stands at 5.7%.

Neither will imbue the Bank with the confidence it needs to make further cuts to the Base Rate.

Is the rise in inflation just a bump in the road or a longer-term problem?

The overall impact on mortgage rates often depends on the magnitude of any interest rate increases and the duration of the higher inflation period. We're yet to see if the recent rise is a bump in the road, or whether we'll quickly return to the target 2%.

For homeowners and potential buyers, it's crucial you monitor economic developments closely. Then, when you're ready, consider consulting with a mortgage advisor to assess the potential implications for your individual circumstances.

This breakdown of the potential effects can help us understand why:

Pressure on the Bank of England:

The central bank's primary goal is to maintain inflation within a target range. The current target figure is 2.0%, which is where we were at before the recent rise.

Any rise in inflation might push the MPC to consider increasing interest rates to cool down the economy and curb price growth. The new Labour government will be aware of a rod they're making for themselves if they don't urge the BoE to keep inflation at or below target.

That may seem ironic, considering we were only recently in a (technical) recession. But the economy has been fighting inflation for months. Just as we began to see light at the end of the tunnel, the dampers came down again. Or, have they?

Potential rise in mortgage rates (emphasis on 'potential'*):

If the Bank of England increases interest rates, mortgage lenders often follow suit. This normally leads to higher borrowing costs for homeowners and those looking to buy a property.

And, not too long in the distant past, average mortgage rates were well above the BoE Base Rate. But that's changed.

Mortgage rates falling, despite the obstinate Base Rate and inflation

At the beginning of the year, the market expected up to a half-dozen cuts to the Base Rate during 2024. Due to sticky inflation, that hope had, in more recent months, dampened to 2-3 cuts this year. Even that now seems hopeful.

This recent rise in inflation may put any further cuts this year in jeopardy. But, given what we've seen this month, that might not mean mortgage interest rates will increase back to where they were.

Why mortgage rates are still falling (but might not for much longer):

Usually, the immediate impact of inflation on fixed-rate mortgages might be limited. But, we've reached the end of August and mortgage interest rates are continuing to fall. It's as if the rule book has been burnt, trampled on and its ashes only then scattered out the window.

Still, it's good news for homeowners.

Many households are still feeling the impacts of the cost of living crisis; after so much economic upheaval, homeowners want to feel reassured. And an increase in buyer activity since the Bank cut the Base Rate suggests that the housing market may indeed have turned a corner.

But, like everything about the market, little's as it seems at face value. Zoopla contests that the lack of activity last year when interest rates were >6% has also contributed to the increase in market activity.

Lenders working on ultrathin margins

Average two and five-year fixed rates have continued to fall, driven by two factors:

• falling swap rates;
• intense competition between lenders.

And the reason we've seen mortgage interest rates fall below the BoE Base Rate is that lenders have been basing those lower rates on swap rates. Swap rates—forecasts for what money may be priced at in the future—have been falling steadily.

Even with falling interest rates, homeowners were still holding out for a better deal. That meant the market was sluggish before the Base Rate cut. That's despite mortgage lenders having worked on ultrathin margins for weeks, if not months. They won't work on such small gains indefinitely.

What would a raise in the Base Rate do to mortgage interest rates?

The Base Rate cut and falling interest rates combined have at least piqued homeowners' interest as August has rolled on. But, given the margins and reductions we've already witnessed, lenders and the BoE alike may decide it's time to put the brakes on further cuts.

If the BoE similarly holds the Base Rate next month—or, worse, puts it back up to 5.25%—it could have dire consequences for mortgage interest rates. That means homeowners holding out for better rates before remortgaging may miss this particular boat.

If you're still not comfortable remortgaging right away, talk to our team about an interim tracker mortgage. You will have options; now's the time to discuss them with a professional.

The last thing we want is for you to endure a lender's SVR. At around 8%, they're so punitive.

Compare the total costs of taking out a short-term tracker against staying on that SVR. You might be surprised how much you can save, even if you pay a fee for the privilege. You deserve better than 8%, surely?!