Interest rates are expected to decrease, but not to the extent that many homeowners consider average. Last week, the Bank of England surprised the financial markets and homebuyers by raising rates by half a percent instead of the anticipated quarter percent. This decision reflects the realization by the majority of the Monetary Policy Committee that rates have not been raised quickly enough. While two external members of the committee voted for no change, there is a disconnect between some academics and the real economy.
It is likely that rates will continue to rise. The yield on one-year gilts is currently around 5.25%, and the two-year yield is just over 5%. This ultimately drives up borrowing costs for everyone. If the government has to pay over 5% to borrow for two years, mortgage borrowers can expect to pay around 6%. Even the most creditworthy homebuyers will pay more than the government.
The challenge now is to prevent higher rates from negatively impacting the economy. Despite the circumstances, the economy is holding up reasonably well. Retail sales increased slightly in May, and the purchasing managers’ index signals continued slow growth. While some individuals have savings accumulated during the pandemic, many families will have to cut back. There is significant pressure on mortgage lenders to prevent foreclosures and protect homeowners.
It is important to remember that most homeowners who purchased their homes two years ago or more will still have a profit, even if it is just on paper, until they decide to sell. Over the 25-year term of a mortgage, the property remains a valuable asset. Maintaining confidence in the housing market is crucial as it directly impacts consumer confidence. Private consumption accounts for approximately 65% of GDP, and confident consumers are necessary to drive the economy until rates can begin to decrease.
Based on my assessment, I believe we are about halfway through the downturn from the market peak in September of last year, and the market will start to recover in early 2024. The timing of the first rate cut will be crucial. Once people can see beyond the high mortgage costs, confidence can be restored. The demand for housing remains strong.
The timing of the first rate cut is dependent on the pace at which inflation declines. While consumer-level inflation remains stagnant, wholesale-level inflation is decreasing significantly. Falling producer prices will take some time to translate into lower consumer prices. Additionally, rising costs in the service industry, due to staff shortages, are a concern. However, we have likely passed the peak of inflation, and the uncertainty lies in the speed and stability of the decline, rather than whether it will continue to fall.
If my assessment holds true, we can expect the first rate cut in the first half of 2024, possibly in February when the Bank of England updates its forecasts in the quarterly Monetary Policy Report. However, this does not mean that the ultra-low rates of the past decade will return, at least not for a generation, and potentially never. It is important to note that prior to 2011, the yield on 10-year gilts had never dropped below 2% in over 300 years. During the past decade, rates reached unprecedented lows, bottoming out at 0.074% in August 2020. Currently, the yield stands at 4.3%.
While interest rates will likely decrease somewhat, they will not return to the levels that many homebuyers have come to consider normal. As always, it is important to make informed decisions in light of the current market conditions and to be aware of the potential impact of rising interest rates.
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