As ructions in the US banking sector demonstrated in March, higher interest rates affect economies in a way that is neither smooth nor linear. Indeed, central bankers have been wary of breaking things as they have rapidly pushed up the cost of credit over the past two years in order to tackle sticky prices. Given the time it takes to hit those who fixed loans at lower rates, a lot of the pain is yet to come. Nowhere is that more true than in the UK, where concerns are mounting over the coming hit to homeowners.
British inflation has proved more persistent than in peer nations. After higher-than-expected price and wage growth data, financial markets now expect the Bank of England’s base rate to rise from 4.5 per cent now to near 5.75 per cent by the end of the year. In turn, banks have briskly pulled and repriced mortgage products. On Monday, two-year fixed-rate mortgages rose above 6 per cent, the highest since December, in the wake of Liz Truss’s infamous “mini” Budget.
Higher mortgage costs will rub salt into the wounds of households already strained by the high cost of living. Overall inflation is at 8.7 per cent, still above wage growth, with food price inflation even higher. The Resolution Foundation, a think-tank, reckons 4.2mn households will have experienced an average annual repayment increase of £1,500 since the BoE’s rate-raising cycle began in December 2021. But it estimates that three-fifths of the projected total increase in repayment costs is still to come.
Next year households remortgaging could face a £2,900 average increase in annual payments. This will come as a severe shock to homeowners accustomed to low rates over the preceding decade. Budgets will tighten significantly, and consumer spending across the economy will slow. Many first-time buyers will rethink their plans, and house prices could well drop further as high borrowing costs curtail demand.
How bad might this get for the wider economy? About 1.3mn people have a fixed-rate mortgage deal that will expire in the 12 months from July 1, or about one-sixth of all households with mortgages. The proportion of homeowners who have mortgages has fallen over recent decades to about 30 per cent, so the pain may be more contained. Rates may also not need to go as high as markets expect, and Britain’s limited housing supply will keep some upward pressure on prices. So a crunch rather than a widespread crash may be most likely.
Higher mortgage costs will still be a political concern for the government ahead of next year’s election, but prime minister Rishi Sunak has rightly ruled out direct support for mortgage holders. Higher mortgage rates are not the same as the systemic and unforeseeable events of the pandemic and energy price surge, which warranted government support. The increase in mortgage payments will be steep, but rules oblige lenders to ensure new borrowers are aware of the risks of rates moving higher.
Financial support would also be misguided in monetary policy terms. The BoE relies on the notion that raising the cost of borrowing will absorb demand. Handing out public money impedes that harsh but necessary process. Rates would need to rise even higher to stamp out inflation, and higher borrowing could push gilt yields up further. That does not mean mortgage holders should get no help, however. Banks should continue to look at how they can support households most at risk of distress — through, for example, temporary adjustments to their mortgage terms, alongside access to budgeting advice.
Ultimately the best way to support mortgage holders is for the BoE to get inflation back down. It has a chance to show it is getting a grip at its meeting on Thursday, when another quarter-point rate rise is expected. Unfortunately for homeowners, things will have to get worse before they get better.
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