On the face of it, there has not been a great deal of good news on interest rates recently, and anyone looking solely at the direction of mortgage pricing could be forgiven for thinking there is not much reason to expect that to change anytime soon.
Bank Base Rate (BBR) of course was held at 3.75% in September, but that has not prevented mortgage product rates from moving higher, with swap rates rising through August and September and lenders having to respond accordingly.
However, one of the strongest messages I took from our recent Landbay Spotlight webinar with Kallum Pickering, chief economist and deputy head of research at Peel Hunt, was that the outlook over the next 12 to 18 months might ultimately prove rather more positive than current market pricing suggests.
That does not mean there will not be further difficulties in the short-term, but there are some important reasons why advisers and their landlord borrower clients should distinguish between what is happening now and what might come next.
What is the market actually pricing?
We have seen two notable periods of mortgage repricing this year, but they have not been driven by precisely the same factors. In March, events in the Middle East pushed oil prices higher, feeding into inflation expectations, wholesale rates and ultimately mortgage pricing, while more recently we have seen another increase in swaps which has been influenced more heavily by movements in government bond yields and the additional risk markets are attaching to the economic outlook.
This matters because BBR is only one component of the rates story, particularly for fixed-rate mortgages. Kallum highlighted that the UK 10-year gilt yield was around 5.3% at the time of our discussion, with markets effectively pricing four BBR increases over the following year alongside inflation rising above 4%.
His view was that this looks too pessimistic, particularly because the domestic economy does not currently show the same underlying inflationary pressures we saw, for example, back in 2022.
The Bank does not have to follow
Another interesting question is whether the Bank of England will feel compelled to follow other central banks if the Federal Reserve and European Central Bank continue raising rates. Kallum's view was that it does not have to, because the UK economy is starting from a different position and monetary policy already looks tight relative to economic growth.
That does not rule out a near-term increase, and indeed he believes the Bank might raise rates once, or perhaps twice, if conditions deteriorate, but he sees four increases as unlikely. More importantly, his expectation is that any such increase would not necessarily signal the beginning of a prolonged tightening cycle, with his expectation being inflation will peak below 4%, potentially around February/March next year, before falling.
From this point, he forecasts BBR being approximately 3.25% by the end of 2027, which produces quite an interesting potential path from where we are today. Rates could conceivably rise in the short term and then be cut sufficiently over the remainder of the period to finish next year below their current level, which is clearly rather different from assuming today's direction of travel will simply continue.
Normal does not mean ultra-low
Greater optimism about rates should not, however, be confused with expecting a return to the extraordinarily low interest-rate environment of the last decade. Kallum talked about a longer-term neutral 10-year rate being around 3.75%, absent the shocks currently affecting markets, which provides some useful context for what a more normal environment might eventually look like.
For advisers and landlords, the question is therefore not whether we are going back to near-zero rates – because we are clearly not - but whether today's elevated market rates accurately reflect where inflation and interest rates are likely to be over the medium term.
If markets are currently pricing too much tightening, then there is clearly scope for that outlook to change, and mortgage borrowers would not necessarily have to wait for the MPC to begin cutting BBR before benefiting because wholesale markets are forward-looking and swaps can start falling as expectations change.
Looking beyond the immediate uncertainty
One of Kallum's more thought-provoking observations concerned economic bubbles, which we tend to regard as uniformly negative. Talking primarily about AI, he argued that periods of very strong investment can leave valuable assets behind even if some of the investment itself eventually proves excessive, and he made a similar point about housing, where increased investment ultimately results in more homes being built.
There is a wider point here about looking beyond immediate risks and considering what investment and improving conditions might produce over time, and I think the same principle is useful when looking at the current interest-rate environment. We should not ignore the challenges facing the economy over the coming months, but nor should we assume today's conditions provide a particularly reliable guide to where we will be in 12 or 18 months.
For the mortgage market, there are certainly reasons to remain cautious, and nobody can know precisely how inflation, geo-political events or monetary policy will develop. However, if inflation does peak below 4%, if the Bank ultimately needs to tighten considerably less than markets currently expect, and if BBR can move towards 3.25% during 2027, then the environment facing borrowers could look considerably different a year from now.
For advisers discussing two and five-year fixes, trackers and future refinancing with landlord clients, that possibility deserves to be part of the conversation. The current rate environment may not prove as permanent as today's pricing sometimes makes it appear, and understanding what markets are pricing for the future is likely to be every bit as important as focusing on where BBR happens to be today.
