UK mortgage rates set to ‘spike’ after bonds market’s spooked reaction to worse than expected inflation rate

Mortgage payers look set to be exposed to another spike in costs after the latest inflation announcement.

Barclays boss CS Venkatakrishnan warned a “huge income shock” is on its way for UK homeowners when they come to remortgage, while market analysts have predicted the Bank of England’s interest rate could climb to highs not seen since 2007. Nationwide Building Society, one of the country’s key lenders, has already announced it has been forced to hike its borrowing rates.

It comes after the latest Consumer Prices Index (CPI) - the UK’s principal measure of inflation - was published on Wednesday (24 May). It showed the rate of price rises fell to 8.7% from 10.1% in April 2023. While the 1.4 percentage point fall was significant, it was not as big as markets and economists were anticipating.

Within the new rate - which has meant the UK retained its ignominious position as the G7 economy with the highest CPI - food prices remained close to record highs, while core inflation actually increased from 6.2% to 6.8%. The latter has been particularly concerning for interest rate setters at the Bank of England given it suggests inflation is proving to be stickier than hoped.

The UK central bank uses its interest rate - also known as the base rate - to control inflation. When it rises, borrowing costs across the economy generally become more expensive.

Borrowers set to face pricier mortgages

Just hours after the inflation news came through on Wednesday (24 May), Barclays chief CS Venkatakrishnan warned mortgage payments would increase as a percentage of household incomes as a result of rising interest rates.

“By our assumptions, for the median family income with the median mortgage, what they have paid as their mortgage or rental payments in the last two decades – the ’90s to 2020 – was about 20% of their income,” he said.

“That is going to be about 28% to 30% of their income. So there is a huge income shock. Obviously it affects consumption, and that is before you even bring in the other effects of inflation being food and energy, and basic goods and services.” He also said he expected most people will start to experience the knock-on effects of higher Bank of England rates by the end of 2024, given the length of most fixed mortgages in the UK is two years.

Venkatakrishnan’s words echoed recent research from think tank the Resolution Foundation, which forecast an average annual increase in mortgage bills of £2,300 (more than £190 a month) for anyone remortgaging between now and the end of 2024.

A day after the Barclay boss’s grim assessment, the UK’s second-largest lender Nationwide announced it would be increasing some of its mortgage rates from Friday (26 May). Customers seeking a new deal, particularly first time buyers with small deposits, will face hikes of up to 0.4 percentage points.

In a statement, a Nationwide spokesperson said: “In the current economic environment, swap rates have continued to fluctuate and, more recently, increase, leading to rate rises across the market. This will ensure our mortgage rates remain sustainable.”

The move was symbolic of the change in the mortgage market’s mood given Nationwide was cutting rates for first-time buyer mortgages little more than a month ago. On 14 April, it reduced a three year fix with a 95% loan-to-value ratio by 0.2 percentage points to 5.24%.

It has not been the only lender to increase its mortgage rates. Lloyds, Virgin Money and Halifax have also announced hikes in recent days. Average remortgaging rates have climbed 0.25% on a two-year fix over the past week, according to comparison site Uswitch.

Markets expecting bigger interest rate hikes

Mortgages have started creeping up after markets began pricing in higher Bank of England interest rate forecasts than had previously been expected.

The consensus on swap markets - which mortgage lenders use to determine how much fixed deals should be - is that the UK central bank will hoist its rate to 5.5% by the end of 2023. Previously, analysts felt a rise to 5% was more likely, while some had predicted the 4.5% rate the bank brought in on 11 May would be its final hike of the year.

However, Mark Harris - CEO of mortgage broker SPF Private Clients - said the “volatile” swap market may be making a “knee-jerk reaction” to the inflation news and may calm down once the announcement sinks in. He added that the markets have been “consistently wrong” about the direction of interest rates since last September.

“Given that inflation has come down, the market reaction has been surprising, with swaps, which underpin the pricing of fixed-rate mortgages, rising sharply,” he said. “The markets have reacted negatively on the back of expectations as to where inflation would be by now, versus the reality.

“Fixed-rate mortgage pricing had already been rising with a number of lenders repricing recently or giving a heads up that they intend to do so. Santander and Halifax are just two lenders who have recently increased their rates and others are likely to follow suit, with short notice.”

Mr Harris predicted mortgage rates would soon peak, with reductions in rates set to be as sharp as the increases have been.

What is also worrying for the mortgage market is what is happening to bonds. The financial instruments are used by the government to borrow money and their prices are affected by the faith investors have in the UK economy. Their yield rate - i.e. the amount they pay out to investors - indirectly influences mortgage rates given the way banks make money out of the loans is by offering more attractive yields than those offered by bonds to lure in investors.

This week, yields on 10-year bonds - the benchmark price for the markets - rose towards the levels seen in the wake of Liz Truss’s Mini Budget last September. They increased 0.2 percentage points on Thursday (25 May) to 4.37% - not far off the 4.5% peak rate seen last autumn. They were just 3.7% earlier in May. It means borrowing costs are likely to rise for mortgage payers.

It has all led to increasing fears a recession could hit the UK, just days after the IMF forecast the UK economy would grow rather than retract over the course of 2023. While recessions usually lead to a fall in mortgage rates as demand among homebuyers drops, they also make it harder for people to buy new property given recessions tend to make job security more precarious. Banks may also be more cautious about who they lend money to.