When will interest rates fall?

Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

UK inflation falls to 2.3% in April

Inflation is nearly back on track said Tom Stevenson, investment director for personal investing at Fidelity International.

“A remarkable round trip to 11.1% and back again is now almost complete, with prices rising at 2.3% in April, close to the Bank of England’s 2% target,” said Tom.

According to the latest data from the Office for National Statistics, falling gas and electricity prices resulted in the largest downward contributions to the monthly change.

“As expected, the main reason for the rapid drop in inflation from the previous month’s 3.2% was falling energy costs on the back of Ofgem’s 12% reduction in the household bills cap. The 27.1% fall in gas, electricity and other fuel prices was the largest on record,” said Tom.

The fall in inflation is encouraging news for the central bank’s Monetary Policy Committee. There is certainly more optimism among the MPC, compared to earlier this year. Although the central bank held rates earlier this month, Bank governor, Andrew Bailey said that the central bank will “need to see more evidence that inflation will stay low before we can cut interest rates.” The MPC will meet in June to discuss the outlook for rates.

Mortgages are already pricing in lower interest rates. Money markets point to a 40% chance of the first quarter point cut in rates coming in June said Tom. A further reduction to 4.75% by the end of the year is forecast.

The  fall in inflation is also good timing for the UK government. Just yesterday, Prime Minister, Rishi Sunak called for a general election in a surprise move. The election will be held on 4 July 2024. 

Current mortgage and savings rates

^{As of  23 May 2024}

• Read more about what 2% inflation means for interest rates, ISA funds and savings 

Dates and data to watch:   

• Retail sales data - 24 May 2024
• UK labour market - 11 June 2024
• Gross domestic product monthly estimate, April - 12 June 2024

How rising and falling rates affect and mortgages and mortgage pricing?

Standard variable rate (SVR) mortgages and existing trackers tend to follow the Bank Rate, but the pricing of new deals is more complicated.

Banks and building societies lend money from deposits taken from customers but also from money they borrow on money markets.

Fixed mortgage deals are influenced by “swap rates”, be it two-year, three-year or five-year pricing, while variable rate deals, such as trackers are more closely aligned to changes in the yields on gilts, UK government debt bonds.

Since swap rates are based on what the markets think interest rates will be, if they rise, then mortgage lenders will increase their pricing to maintain their profit margin. If they rise too rapidly - mortgage lenders may have to pause lending or withdraw products until pricing stabilises.

When rate market pricing shifts, it steadily filters through to changes in mortgage pricing. A fall in swap rates is often followed by a fall in the rates being offered on new fixed mortgage deals, although this is never guaranteed given the many factors at play.

UK mortgage borrowers’ sensitivity to rates

The UK central bank is particularly mindful of the impact rate changes have on UK consumers.

Some markets, such as the US and Denmark, traditionally have mortgage rate terms of 20 to 30 years. In Britain, Canada and much of Southern Europe, short-term deals pervade.

It means that in the UK, most homeowners are currently on a fixed-rate mortgage, making it the most common type of mortgage.

The Bank of England is acutely aware that millions of people will see these arrangements, some fixed at rates below 1%, coming to an end in the coming years, with those borrowers compelled to take far higher rates.

As of 23 May 2024, the average two-year mortgage fell to 4.61% versus 4.82% on 9 May. The average five-year mortgage has also seen a fall from 4.45%, to 4.32%. 

A peak in savings rates?

Savings rates, of course, are also part of this maelstrom of market pricing. The change in forward market pricing may put pressure on banks to withdraw some of the best buys on offer. Although again, these markets are volatile, and nothing is certain. Given inflation has fallen, saving rates now exceed inflation which currently stands at 3.9%.

As of 9 May 2024, the best return savers can currently get on easy-access cash accounts is 5.01%² although higher rates are available if you tie money up for periods.

The best fixed-term savings account offers 5.21% if you lock in for a one-year fix.

And finally… annuity rates

Aside from increased savings rates, another silver lining of the recent surge in Bank Rate has been improved annuity rates. With annuities, you hand over a lump sum and received an income, often inflation-linked, for the rest of your life. These rates were appallingly low in the era of low rates but have enjoyed a renaissance. Annuity pricing is influenced by the yields on gilts. The 10-year gilt yield currently stands at 4.27% (23 May 2024). If you sign up to our Pulse alerts, you'll be the first to know when forecasts move.

The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

Sources:

¹  The Times, 4 May 2024
² Money Saving Expert, 4 May 2024