Why your mortgage will be cheaper by Christmas

Anyone with a variable-rate mortgage or a cheap fixed-rate deal about to expire is probably feeling a little nervous right now. Interest rates have shot up by 0.75 percentage points to 5.25 per cent in the last six months and speculation is rife that borrowing costs could rise to as high as 6 per cent in the next few months.

But will rates really go that high? And if they do, how long will they stay that high?

Today the minutes of last month’s Monetary Policy Committee meeting at the Bank of England – when rates were hiked unexpectedly by 0.25 per cent – were released. They revealed that the vote on the nine-member panel was a surprisingly close 5-4 in favour of the rate hike. Could this division suggest that the Committee is unlikely to raise rates again soon? Possibly. At the least, it makes the chances of a rate rise in February less likely. However, it must be noted that at least two of the members who voted against higher rates were not against the move in principle, they merely objected to its timing.

Whether rates go higher in March or April and possibly again later in the Spring will depend on the how wage settlements develop over the coming months. If earnings growth shoots up the Bank is almost certain to hike rates to avoid an inflationary wage – price spiral. Mervyn King, the Governor of the Bank of England, said as much in a speech he gave to the Birmingham Chamber of Commerce last night. The Bank will also asses inflation expectations and the pricing power of companies.

But if wage growth proves benign, there is a possibility that the Bank will not hike rates again this year. Even in the probable event that the Bank does raise rates again this year, there is a significant chance that rates will begin to fall back by the end of the year. There are a number of reasons for this. Firstly, higher rates, and the associated higher level of sterling, along with the impact of slower US growth will combine to limit UK growth – possibly below its long-term trend level. This extra capacity in the economy will allow the bank to cut rates without the risk of stoking inflation. In fact, higher rates now could be a risk to growth and the Bank might be forced to cut rates to stimulate the economy.

The second reason why rates are likely to fall in the second half of the year is that inflation will begin to fall back. Many of the factors that have contributed to the recent spike in inflation have been temporary and beyond the Bank of England’s control. For example, food and energy prices have spiked and tuition fees have been included in the inflation figures. As the effects of last year’s price spikes in these areas drop out of the annual inflation figures, the headline inflation rate will begin to fall. Higher sterling will also help limit inflation.

With the Consumer Prices Index of inflation back at or even below its target level of 2.0 per cent the Bank will be able to ease the monetary screws. Expect to see rates of no more than 5.25 per cent, and possibly less by December 2007.

Comments

[west]

just because the demand!

[Giles Healy]

Interesting thoughts, but many analysts see oil and energy prices returning to an upward trend this year. Oil may have fallen roughly 30% in price from it's highs to a recent low of under $50.00 a barrel, but since the beginning of the year it has risen more than 10%. With slashed Opec production, Iran's nuclear programme, fears of civil war in Iraq dragging neighbouring countries in to the fray, Russian energy blackmail of western European customers, etc., etc. I would bet on interest rates staying high or perhaps rising further.

[Boz]

Why on earth should mortgage payers service the consumer debts of idiots with credit cards? As a mature student with family and only a modest mortgage, I am annoyed that I subsidise overspending by people living beyond their means.

[Newton]

I am reading this article on 27th June 2007 and it puts into perspective the views of all economic writers and forecasters. The main impression I have is that economic forecasting is just like weather forecasting. It can be right in the short term, but is usualy unreliable in the long term.