On 22 June, the Bank of England (BoE) raised the UK base interest rate by 0.5 percentage points to 5%.
This represents the 13th consecutive time that the BoE have hiked rates in just 19 months, and UK interest rates now sit at their highest level since 2008.
The knock-on effect of these increases has been that mortgages have become significantly more expensive since late 2021. Indeed, Moneyfacts reports that, if you want to refinance on a fixed-rate mortgage right now, you will find the rates are around 3% more than they were just a year ago.
So, why have interest rates risen so sharply and so high? What does it mean for you? And when are they likely to fall again? Read on for answers to these questions and more.
The Bank of England has been increasing the base rate to combat high inflation
The primary reason for 13 consecutive interest rate hikes is the control the UK’s stubbornly high inflation rate.
Huge spikes in the cost of food and energy – caused by a spike in demand after the pandemic and the war in Ukraine – have seen prices rising at levels not seen for four decades.
While the rate of inflation has been falling, the Office for National Statistics report that it stood at 8.7% in the year to May 2023. Essentially, this means that goods and services that cost £100 in May 2022 cost £108.70 today.
The theory is that higher interest rates make it more expensive for people to borrow money and encourage people to save. Overall, that means people will tend to spend less.
If people spend less on goods and services overall, the prices of those things tend to rise more slowly, leading to a lower rate of inflation.
Interest rates are now at a level not seen since the global financial crisis, as you can see from the graphic below.
Source: Bank of England
As inflation is proving more stubborn than predicted, the BoE have said that they are prepared to raise interest rates even further, even if that pushes the UK economy into recession.
Rate rises mean the cost of borrowing has risen sharply
The knock-on effect of a higher base rate is that the cost of mortgages has risen sharply over the last couple of years.
This is Money provide a useful example.
In June 2021, the average two-year fixed rate for a borrower with a 25% deposit was 2.17%. The average rate on the same mortgage now is 5.94%.
If you had a £200,000 repayment mortgage over 25 years, the repayments would have risen from £864 a month to £1,281 – a £417 difference.
In June 2018, the average five-year fixed rate mortgage for a borrower with a 25% deposit was 2.72%. The average rate on the same mortgage now is 5.67%.
Using the same example. If you had a £200,000 repayment mortgage over 25 years, your repayments would have risen from £920 to £1,244 each month.
Additionally, mortgage rates in the UK are higher than in other countries. The Evening Standard reports that interest rates on average were 2.91% in France, 3.61% in Belgium and 3.89% in Germany.
For a £200,000 loan paid back over 25 years, annual UK mortgage payments are around £1,100 higher than in Belgium and Ireland, and about £800 more than in Germany and the Netherlands.
Interest rates set to keep rising
More worrying for borrowers is the fact that the recent hike to 5% is unlikely to be the last interest rate rise.
With UK inflation still significantly higher than the BoE target of 2%, most experts forecast that the BoE will continue to raise rates throughout 2023. This is Money say that “the most pessimistic economists and market commentators see it peaking as high as 6%”. This is more than 1% higher than when the BoE delivered its last rates decision in May 2023.
These forecasts have already filtered through to the cost of mortgages. Both the yields on gilts (the rate on UK government borrowing) and swap rates – the money market rates that lenders use to set fixed-rate mortgage pricing – have increased substantially.
The average two-year fixed mortgage rate increased from 5.34% on 19 May 2023 to 6.19% on 22 June.
The question: “when will interest rates fall?” is much more difficult to answer.
The BoE are only likely to pause any further increases in rates when inflation starts to return towards the target of 2%. In their May report, the BoE said they expected to meet the target “by late 2024”.
Similarly, mortgage rates are only likely to peak, and then begin to fall, once inflation is under control. This could well be in late 2024 or 2025.
Our advice is not to rely on any reduction in the cost of borrowing in the short term and to plan for mortgage rates remaining at these high levels.
Our article about five ways to keep your mortgage costs low shares some practical advice. Additionally, if you are worried about rising rates and you’d like to review your options, please get in touch.
Email [email protected] or call us on +44 (0) 20 3411 0079.
Please note
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
