Recently, there’s been a fierce competition among mortgage lenders in the UK, leading to a significant drop in mortgage rates. Since the start of the year, over 50 lenders have slashed their residential rates. This trend was fueled by expectations that the Bank of England would reduce the base rate once inflation was under control. As a result, fixed mortgage rates have reached new lows. For instance, Santander just lowered its two-year fixed rate from 4.55% to an impressive 4.1%.

The Unexpected Inflation Spike

However, this downward trend in mortgage rates might be hitting the brakes soon. The recent surprise increase in December’s Consumer Price Index (CPI) inflation – which rose to 4%, higher than the anticipated 3.8% – has caused a stir. This unexpected inflation jump has led to financial markets reassessing their expectations for base rate cuts this year. Previously, six rate cuts were anticipated for 2024, but now, forecasts suggest only four or five cuts.

Market Reactions and Predictions

The market’s reaction to the inflation data has been to dial back the extent of predicted base rate cuts – from 170 basis points (bps) to 115 bps since January 1. Andrew Wishart, a senior economist at Capital Economics, noted that Santander’s decision to cut rates likely preceded the release of the December inflation data. Despite this, lenders like Santander may still profit, albeit modestly, considering the current savings rates.

Wishart points out the unusual nature of Santander’s move, lending at rates lower than what they would earn from risk-free government bonds. This intense competition among lenders, driven by targets or PR motives, is a significant factor in the current mortgage landscape.

How Mortgage Rates are Set

Understanding fixed rate mortgage lending involves looking at Sonia swap rates, which reflect market expectations and influence banks’ fixed rate pricing. Swap rates indicate what banks predict for future interest rates. Presently, five-year swaps stand at 3.71%, and two-year swaps at 4.26%, both below the current base rate. However, these rates have slightly increased since the start of the year.

Chris Sykes, technical director at mortgage broker Private Finance, notes that it’s rare for the lowest mortgage rates to fall below swap rates. With Santander’s rate at 4.1% against a 4.26% swap, he doesn’t expect this deal to last much longer.

Future Expectations

Wishart believes that mortgage rates will stabilise between 4% and 4.5%, closely aligning with swap rates, which are unlikely to decrease further without an actual base rate cut by the Bank of England.

As for the future, if the Bank of England starts reducing the base rate, Sykes expects further downward pressure on mortgage rates. However, he cautions that significant rate drops shouldn’t be anticipated immediately when the base rate falls, as much of these reductions are already factored into current mortgage offers.

A Word of Caution

In light of the recent inflation data, Wishart warns of the potential for interest rates not falling as expected, which could lead to a rise in both swap rates and mortgage rates. This development underscores the uncertainty in the current economic climate and its impact on the housing market.