1. Why have interest rates been rising?
Britain has the worst inflation problem in the Group of Seven nations, buffeted both by an energy crisis affecting all of Europe and a US-style workforce dropout rate. Despite warnings of a recession, a lack of workers to fill open jobs is forcing companies to bid up wages, feeding the upward spiral in prices that’s led the Bank of England to raise interest rates at the sharpest pace in over three decades.
2. Will interest rates keep on rising or have they peaked?
The BOE has signaled that rates will stay high for a prolonged period until inflation is brought under control. Inflation is still running at more than triple the bank’s 2% target. As of Oct. 4, markets were assigning around an 80% chance to another rate rise by February 2024. But many economists think the BOE is now done after halting its hiking cycle in September. Homebuyers may need to adjust to the idea that the rock-bottom interest rates embraced after the 2008 global financial crisis were an exception rather than the new norm. BOE Chief Economist Huw Pill has advocated a “table mountain” approach where rates stay high and flat for a long period. “Economic data is unlikely to cause enough alarm for the central bank to hike again,” Dan Hanson, senior UK economist at Bloomberg Economics wrote after the BOE’s monetary policy committee decided to hold rates steady at its September meeting. “We now expect interest rates to remain on hold until the second half of 2024.”
3. What’s been the impact of interest rate rises on mortgages and the housing market?
Millions of mortgage holders are finding much of their disposable incomes eaten up by higher interest payments. The risk is that the growing hit to consumer spending from higher repayments tips the country into a recession as the BOE keeps up the pressure on inflation. House prices have been falling at their sharpest pace since 2009, with data from mortgage lenders suggesting the slump is a little more than half way to the 10% drop that economists anticipate.
4. Why are UK mortgages an economic weak spot?
Rising house prices were a driver of UK economic growth after the financial crisis. Total mortgage lending reached £316 billion ($381 billion) in 2021, the highest since 2007. People today spend a lot of their income on housing: The average UK house cost around nine times average earnings in late 2022. That’s the highest since 1876. Loans to finance those purchases were more affordable when the BOE’s benchmark lending rate was near zero. Now it’s 5.25% and likely to rise. While those rates are still lower than they were in the late 1980s, households now have much larger loans — and bigger in comparison with their income.
5. Why is the UK mortgage market so sensitive to higher rates?
The vast majority of UK mortgage holders have fixed their interest rates for just two or five years, unlike in many other countries where 10-year and 30-year fixed mortgages are more common. It’s still a better situation than in previous decades, when the majority of households were on variable-rate deals that exposed them immediately to volatile interest rates. Still, lots of households face sharply higher repayments when their fixed-rate deals end and they need to negotiate new terms — 1.3 million of them between April and the end of the year. With the country already gripped by a cost-of-living crisis, many will struggle to pay thousands of pounds more per year on their mortgage.
6. How will high rates affect people’s spending?
The Institute for Fiscal Studies estimates that higher interest rates will cause the average mortgage holder to suffer an 8.3% fall in disposable income compared to a scenario where rates remained at March 2022 levels. For 1.4 million of those borrowers, disposable income will fall by more than 20%. Consumer confidence would be dented further if there’s a sharp fall in property prices. All this doesn’t only affect home owners. Rental costs are also soaring as landlords with mortgages pass on their higher borrowing costs to their tenants.
7. What’s the political fallout?
The surge in mortgage rates is worsening a housing affordability crisis blamed on decades of underinvestment in new homes. For the governing Conservative party, home ownership has been core to its appeal to voters since the 1980s. Years of rock-bottom interest rates and low levels of home building increased property values in recent decades and made homeowners feel richer, but it’s now much harder for younger people to afford a first home. And it’s not just aspirational voters who are affected. The mortgage crisis also hurts the approximately 30% of households who already have the loans, a demographic that skews older and wealthier and tended in the past to vote for the Conservatives. With national elections looming in 2024, the mortgage crisis represents another liability for a governing party that’s been trailing well behind Labour in most opinion polls.
8. What’s the situation in other countries?
Mortgage markets vary widely across the world. While Sweden, Canada and Australia, for example, have a similar focus on shorter-term loans, in the US, 15- and 30-year fixed-rate mortgages are standard, and it’s a similar story in many continental European markets, including Germany, Belgium and France. France also limits how rapidly lenders can pass rising interest rates onto existing borrowers. This all means that existing borrowers in these countries are largely sheltered from rising rates. On the other hand, longer-term mortgages can also be inflexible. One problem affecting the US housing market right now is that mortgages are generally not portable, so homeowners feel unable to move house because they will lose their current low rate and have to refinance at a much higher level.
9. How bad could it get?
Economists don’t expect the UK to face a negative equity crisis — the moment when prices crash and millions of people find their houses worth less than their mortgages. Prices surged by 27% between the start of the pandemic and their peak in 2022, providing a buffer to guard most households from the risk of negative equity. Unemployment is also still relatively low at 4.3%, reducing the threat to house prices from a wave of forced selling. UK households have also been stress-tested against the risk of a surge in interest rates, meaning many have already proven they can afford a painful jump in interest costs.
More stories like this are available on bloomberg.com
