Prospects for UK Mortgages 2007-2008

The Bank of England recently increased interest rates for the forth time in 9 months to 5.5%, thereby increasing the cost of mortgages. The prospects for future interest rates are mixed, although most commentators expect rises in the short term.

April inflation figures showed that inflation has fallen back within the governments inflation target of 1-3%; CPI inflation is now 2.8%. The older measure of inflation, RPI (which includes mortgage and housing costs), also fell to 4.5%.

Overall, evidence suggests that the Bank of England is still likely to rise interest rates further in 2007. This means that mortgage costs, for those on variable mortgages, will continue to rise. (e.g. £120,000 mortgage will see a £22 rise from even a quarter point rise in interest rate)

Reasons for increased interest rates include:

1. The Bank of England is keen to maintain a hawkish stance on inflation. It wishes to reduce inflation to 2% and not allow it to remain close to the upper level of 3%. Mervyn King, hinted at this stance in a recent announcement. [2]

2. There are still underlying inflationary pressures in the economy. An increasing number of suppliers are experiencing supply constraints.
Manufacturing Output is showing signs of renewed growth [1] Retailers are also saying they feel that they can get away with passing cost increases on to consumers. Something absent in recent years.

3. Retail Price inflation is higher than CPI. At 4.5% it is significantly higher than the old RPI target of 2.5%. Most pay deals are based on RPI, it is viewed as a more reliable measure of the actual cost of living.

However, despite these inflationary pressures. There are good reasons to believe that the cost of mortgage borrowing may start to fall by the end of 2007; by 2008 interest rates may be able to fall by even more.

1. Interest rates often have a delayed impact on spending and the economy. The 4 previous interest rates changes are now starting to have an effect, (due to high levels of personal debt) small rises in interest rates may have a significant impact on the economy.

2. House Price rises are still in double figures. However, many analysts are confident that rising interest rates will put an end to the long housing boom. Increasing unaffodability of Housing also increases chance of lower house price inflation. This may bad news for homeowners, but it will enable lower interest rates and lower mortgage payments.

3. Gas and Electricity prices expected to fall. Last year saw record rises in Gas prices, due to supply constraints. Now these supply constraints have been fixed it is likely gas prices could fall by as much as 20%.

4. Low global inflation. The benefits of globalisation are still in evidence. For example, the price of manufactured goods remains low. Inflation in the EU and US also, continues to be low.

Related Posts

• Prospects for Interest Rates 2007-2008
• Will House Prices Ever Fall?
  

Mortage Approvals up but Inflation threatens to rise

After a slowdown in mortgage approvals in December The number of mortgage approvals increased to 120,000 in January, according to figures released by the Bank of England.

However the CBI report an upward pressure on prices from the factory gate. This continued inflationary pressures increases the likelihood of further interest rate rises in the UK.

Andrew McLaughlin, chief economist at RBS said:

"Prices-charged inflation hit a series high while cost inflation remains elevated. Such signs that inflationary pressure is still building in the manufacturing sector, coupled with strong manufacturing growth, should provide additional ammunition for the more hawkish members of the MPC."

RBS produce the stats for the CIPS (Chartered Institute of Purchasing and Supply)
However some economists are now speculating that if the global stock market uncertainties spill over into the UK economy the likelihood of interest rate rises may diminish.

UK January Inflation figures good news for homeowners

The latest CPI inflation figures released by the bank of England show that the main inflation rate was 2.7% in January. This is a fall of 0.3% on the December figures.

However the old method of calculating inflation, the RPI was 4.2%. This higher inflation figure is mainly because it includes mortgage interest payments. The latest RPI inflation figures are high because they include the recent quarter point rise in inflation.

The main downward pressures on inflation this month are from falling petrol and fuel prices. Also some communication costs and airtravel is lower than this time last year.

The effect of a lower inflation rate means that there is less necessity for an interest rate increase in the near future. With the Bank of England Governor claiming that inflation is likely to fall in the second half of the year it is even possible that the interest rate cycle has peaked.

However there are still inflationary pressures in the economy. These are coming from a resilient housing market and strong economic growth. GDP growth is currently 3% which is slightly above the long run trend rate of growth.

The Role of the Bank of England

The Bank of England performs several tasks in the UK economy.

1. It issues notes and coins. The Bank of England is the sole issuer of notes and coins in the UK. In theory you could take a £10 note to the Bank of England and ask for you equivalent sum of Gold. I don't know whether they would take kindly to such requests but in theory that is how they maintain confidence in notes and coins as a medium of exchange

2. Managing the government’s debt. National Debt in the UK At the end of 2005/6 general government debt was £529.1 billion, equivalent to 42.1 per cent of GDP. [1]
To manage the government debt the bank of England sell bonds and gilts to the private sector. Usually bonds have a lifetime of about 30 years. In order to encourage people to buy government debt they need to offer an attractive interest rate. Interest payments on UK debt amount to nearly £30 billion a year

3. Managing Monetary Policy. In particular the MPC Monetary Policy Committee is responsible for changing interest rates in order to keep inflation within the governments target of CPI 2% +/-1. To achieve this inflation target the MPC meet every month and examine future inflation trends. If inflation looks to be increasing then they will vote to increase interest rates in order to dampen demand.

4. The Bank of England actually set the base rate of “repo” rate. This is a rate at which they lend to the commercial banks. They keep the banks short of liquidity so that they often have to borrow on this repo rate. If this repo rate changes then the commercial banks usually pass the changes on to their customers by changing there own interest rates.

5.. Acting as lender of last resort. If the commercial banks are short of cash then they go to the Bank of England who will be able and willing to lend them money. This is important for the banking system because it ensures the banks are never short of cash and so people have confidence in the banking system.

6. The Bank of England oversees the banking and financial system of the UK

[1] http://www.statistics.gov.uk/cci/nugget.asp?id=277

Have interest Rates in UK peaked already?

Recent increases in the interest rate suggest that there are more increases on the way. Inflation has reached 3% which is at the upper limit of the Banks CPI inflation target. Furthermore the UK housing market appears as buoyant as ever. House prices continue to rise to record levels (£137,000+) With this backdrop of rising inflation and rising inflation it suggests that interest rates may have to continue rising.

However on the other hand the Governor of the Bank of England has suggested that he expects inflation to fall sharply in the second half of this year. Much of last months increase in inflation is due to rising energy prices and tax. When these are taken away the inflationary situation doesn't appear quite so bad. If this is the case and if house prices start to slow down the need to increase interest rates will diminish significantly.

Higher Interest Rates not so Likely

News that the recent MPC committee only narrowly voted for a rate rise, suggests the likelyhood of the next rate rise is unlikely to be up. The final vote was 5-4 with Mervyn King casting the final vote in favour of a rate rise. Mervyn King also made an uncommon prediction about future inflation. He states he believes that inflation is likely to fall in the second half of the year. - Possibly quite sharply. This will come as good news to UK homeowners as it makes future interest rates harder to justify. However there is still evidence the UK economy is performing robustly with economic growth above long run trend rate of growth.

See state of UK economy in 2007

Bank split on January vote

Bank of England Video on Money

Bank of England have a video about the usefulness of money. (would make a good video for my AS economics students) Pretty down to earth for the Bank of England.

"It would be pretty hard to buy a CD if you didn't have any money"

Via: UK Economics

The bank have been given a target for Inflation of CPI 2% =/-1 Inflation does have many costs such as uncertainty, confusion and "Menu Costs". Chancellor Norman Lamont famously said in 1991 or 1992

"Unemployment is a price well worth paying for lower inflation". It caused a bit of a storm at the time, there were nearly 3 million people unemployed. However you could argue that since inflation has been reduced since the late 80s boom the UK has experienced a remarkably stable period of economic growth, consistent with low inflation. Maybe reducing inflation was a necessary evil. The MPC approach since then has to be pre emptive. I.e. reduce inflation before it becomes a real problem. The hope is that this makes it less painful to reduce.

However on the other hand Central bankers can sometimes get carried away by low inflation. For example in the 1990s the Japanese financial authorities still had concerns over inflation despite persistent deflation and a stagnant economy.

UK Inflation and Interest Rates both Rise

The Bank recently announced a rise in interest rates to 5.25%. This was unexpected at the time, however inflation statistics a couple of days later seemed to entirely justify their decision. CPI inflation rose to an 11 year high of 3%. By historical standards 3% is not too bad, but the Bank of England will be keen to maintain their impressive anti -inflationary credentials and avoid future inflationary pressures. Therefore the prospect for homeowners is not looking too good for 2007. Interest rates may have to rise further to reduce spending sufficiently to prevent inflation exceeding its target.

Full article: Prospect for UK interest Rates 2007


Prospect for House Prices 2007

UK Interest Rates increase again

Why Interest Rates were increased again to 0.25%

To the dismay of householders and industry, the Monetary Policy Committee unexpectedly increased interest rates for the third time in only 6 months. Interest rates now stand at 5.25%. Although the increase was only a quarter of 1%, it will add considerable financial burden to the UK’s overstretched borrowers. For example somebody with a mortgage of £100,000 will find themselves paying an extra £15, or £21 for an interest only mortgage.

The citizens advice bureau warned of financial disaster for some families, especially since it comes in the difficult post Christmas spending period. The CBI also expressed its regret. The CBI are worried on behalf of exporters. The rise in interest rates has further increased the value of the £ making British exports less competitive. The pound rose yesterday to nearly $2 per £1. Given the impact on borrowers and increased risk of insolvency many have questioned the banks motives.

The Monetary Policy Committee have defended their decision by saying that inflation is still above the government’s inflation target. CPI Inflation is currently 2.7%. However some argue that this is only a small divergence between their target of 2%. The key thing is the future course of inflation. Next month the MPC will produce their inflation report, this could be key to deciding whether interest rates have to rise further. The MPC also cite other inflationary pressures; such as the ever-resilient housing market. House prices rose by 3.3% in the last 3 months giving another unsustainable rise. The MPC also cited increased wage pressures. The latest wage settlements have been averaging around 4%, a figure the MPC argue could lead to further inflation; the CBI however were disputing the inflationary impact of wage rises. Perhaps the most significant justification for the interest rate rise is that this pre-emptive move will prevent future interest rate rises. If the MPC can dampen consumer spending early it will prevent a future inflationary situation. This pre-emptive inflationary strategy is exactly what Gordon Brown had in mind when the MPC were made independent in 1997.

However some economists are increasingly aware of the limitations of monetary policy. The effects of raising interest rates are not equally spread across the economy. First time buyers and usually young people with high levels of borrowing will definitely feel the financial pinch. However there is a significant proportion of the economy sitting on equity gains from rising house prices, these consumers have also usually paid off most of their mortgage. Therefore higher interest rates do not dampen their spending. In fact the elder generation are often helping out their children with equity for buying a house. This and the influx of foreigners into the housing market is maintaining healthy demand despite the increased interest rates. The effect of this is that rising interest rates may have less impact on reducing inflationary pressures. Increasing the likelihood of future inflationary pressures.

Effect of Rising Interest Rates in UK

The Future of Interest Rates in UK (Nov 2006)

UK Interest rates at BBC