The recent turmoil in the US banking sector during March highlighted the non-linear and unpredictable impact of higher interest rates on economies. Central bankers have been cautious in their approach to raising the cost of credit over the past two years in order to address stubborn inflation. However, the effects of these rate hikes will take time to fully materialize, especially for homeowners in the UK who are now facing mounting concerns.
Compared to other countries, British inflation has proven to be more persistent. Following the release of data showing higher-than-expected price and wage growth, financial markets now anticipate that the Bank of England will raise its base rate from the current 4.5% to nearly 5.75% by the end of the year. As a result, banks have swiftly withdrawn and repriced their mortgage products. On Monday, two-year fixed-rate mortgages reached over 6%, the highest level since December, following Liz Truss’s significant adjustments in the “mini” Budget.
These increasing mortgage costs will exacerbate the financial strain already experienced by households due to the high cost of living. Overall inflation stands at 8.7%, still surpassing wage growth, with food prices experiencing even higher inflation. The Resolution Foundation, a think-tank, estimates that since the Bank of England’s rate increases began in December 2021, 4.2 million households have faced an average annual increase of £1,500 in their mortgage repayments. However, it predicts that three-fifths of the projected total increase in repayment costs is yet to come.
In the following year, households remortgaging could face an average annual payment increase of £2,900. This will come as a significant shock to homeowners who have become accustomed to lower rates over the past decade. As budgets tighten, consumer spending across the economy will decline. Many first-time buyers will reconsider their plans, and the demand for houses may decrease, resulting in further price drops.
What does this mean for the wider economy? Approximately 1.3 million people have fixed-rate mortgages that will expire within the next 12 months, accounting for about one-sixth of all mortgage-holding households. With the proportion of homeowners with mortgages having declined to around 30% in recent decades, the impact may be somewhat contained. Additionally, market expectations of interest rates may not necessarily reach the levels currently anticipated, and the limited housing supply in Britain will exert upward pressure on prices. Therefore, it is likely that we will experience a crunch rather than a widespread crash.
Higher mortgage costs will undoubtedly be a concern for the government before next year’s election. However, Prime Minister Rishi Sunak has rightfully ruled out direct support for mortgage holders. Unlike the unprecedented events of the pandemic and energy price surges, higher mortgage rates do not warrant government intervention. While mortgage payments will significantly increase, lenders are obligated to ensure that new borrowers are aware of the risks associated with rising rates.
Financial support would also be misguided from a monetary policy perspective. The Bank of England relies on the concept that raising borrowing costs will help curb demand. Providing public money would hinder this necessary but harsh process. Additionally, rates would need to rise even higher to combat inflation, and increased borrowing could further push up gilt yields. However, this does not mean that mortgage holders should receive no assistance. Banks should continue to explore ways to support households that are most at risk of distress, such as temporarily adjusting mortgage terms and providing access to budgeting advice.
In the end, the most effective support for mortgage holders is for the Bank of England to bring inflation back down. The upcoming meeting on Thursday presents an opportunity for the bank to demonstrate its capability in addressing this issue, with another anticipated quarter-point rate increase. Unfortunately, homeowners may have to endure further hardships before improvement is seen.
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