Base Rate Gamble: To Fix or Not to Fix?

Ahead of the publication of the minutes from this week’s Monetary Policy Committee meeting and in light of comments made by the shortly outgoing governor, latest swap rates are indicating an estimated 80 per cent likelihood of base rate falling to 0.50% at midday on Thursday (30 Jan). At the time of writing (23 Jan), two year money has dipped from 0.71% to 0.58% and five year from 0.78% to 0.65% since New Year, following the Governor’s dovish notes of caution on economic activity and latest inflation data. 

Note – since writing this on 23 Jan, latest IHS-Markit economic data suggests that in fact, the economy could return to growth in January with predicted GDP growth of 0.2% potentially staving off any imminent base rate cut. This might mean you want to stop reading here. However, for those intrepid and ambitious readers, I’ll press on regardless. 

So what does a potential base rate cut mean for mortgage rates? Should you hold off securing you or your client that five year fix in hopeful expectation of rates plumbing new depths? Unhelpfully, but as we regularly caution in our industry, past performance provides no indication of future success. 

Base rate last fell in August 2016 when rates were cut from 0.50% to a record low 0.25% with the first base rate cut in seven years triggered by Brexit uncertainty and grim economic forecasts. Analysis of historic UK Finance data from the months prior to the August 2016 cut shows that by the time of the August announcement, average mortgage rates had already fallen by the full 25bps as lenders priced in the forecast cut to on sale mortgage deals up to three months before base rate moved. No surprises there - the market widely expected a BBR cut and had ample time to prepare. 

And yet this doesn’t tell the whole story. In the months immediately following the August 2016 cut, on sale mortgage rates continued to plummet with two year deals falling a further 27bps and five year deals falling 19bps in the six months from August 2016 to February 2017. In fact, such was the depth of the fall in mortgage rates that it took until April 2018 – and a subsequent base rate increase – before two year rates moved back up beyond their pre-cut levels. 

More interestingly (if this is your thing), five year rates haven’t risen at all, with the latest five year fixed rate average continuing to sit below the level seen in August 2016, despite a two subsequent 0.25% increases in base rate.

Much of this is simply market dynamics. The super cheap long term fixed rates (think 5yr at sub 1.50%) seen in the run up to Christmas (who knew we'd started a ‘rate war’ by the way), were made possible by an inverted yield curve (for the very brave) with longer dated money significantly cheaper than shorter term, as markets forecast significant uncertainty and low to no growth. However, the incredible value of cheap longer term deals has in turn stoked up customer demand with the resulting market forces continuing to keep prices low even as swaps have started to rise.  

Returning then to the ‘fix or no fix’ question in the run to Thursday’s announcement. History provides us with little help. Base rate movement is just one strand in the complex web of macroeconomic factors and market sentiment that drives mortgage rates. Unpicking the mesh of consumer confidence, lender risk and growth appetites, economic performance, house prices, inflation and unemployment indicators to in turn make predictions on future interest rates is very difficult for the amateur (as this blog itself has demonstrated). 

And yet, history does teach us one clear lesson. Regardless of whether you’re a hawk or a dove, a gambler or a banker, the safest bet remains to ensure that you can afford the repayments on any new loan, should the worst happen. On that at least, I’m sure we’d all agree.