Mortgage Interest Rates Predictions for 2008

In recent months there has been a noticeable slowdown in UK house price growth. In the US, the Housing market is stuck in the doldrums with some areas seeing falling house prices.

With the slowdown in the housing market, it is less likely that interest rates will have to rise any further.

Furthermore recent inflation figures in the UK, showed an unexpected fall in inflation to below the government's target of 1.9%. BBC link

This fall in inflation suggests that previous interest rate increases are starting to have an increasing effect in reducing inflationary pressures.
The lower inflation was also as a result of falling food prices. The RPI measure also fell from 4.4% to 3.8%. The RPI measure is seen as a more accurate measure of inflation because it includes all housing costs.

Royal Institution of Chartered Surveyors (RICS), also recently pointed out that demand for buying a house fell at the fastest rate in 3 years.
Have Interest Rates Peaked?

With evidence of a slowdown in the housing market as well, it suggests interest rates do not need to rise any further. However, the Bank of England has been keen to maintain its anti inflationary / hawkish stance. They suggest that interest rates could still rise. They point to factors such as:

• High levels of borrowing in the UK.
• Relatively Strong growth in the Manufacturing sector.
• Although house prices are not increasing as much, they are still increasing.

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Interest rate increase seen as unlikely at FT

How much can I borrow on my mortgage?

Inflationary Pressures build in UK

Despite the recent fall in UK CPI inflation to 2.8% there is evidence of increasing underlying inflationary pressures in the UK.

• Growth last year upgraded to 2.9% (Source: office of national statistics)
• OECD raise forecast growth rate to 2.7% (slightly higher than the UK's long run trend rate of growth)
• Rising wage settlements (2% in the last quarter)
• Wages are rising, especially in the financial sector, where bonuses are at the highest since the early 1990s.
• GDP deflator rose to 3.2% in the last quarter. (this is a measure of price rises and is used for converting nominal GDP statistics into real GDP statistics)

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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.

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Prospects for Interest Rates in the UK May 2007

Today, Thursday 10th May, the Bank of England increased interest rates to 5.5%. This is the highest rate since October 2001. Interest rates have increased by 2% since a low of 3.5% in 2003.

The main reason for the increase in interest rates were:

1. CPI Inflation increasing to 3.1%. This is just above the government's target, last month the governor of the Bank of England had to write a letter of explanation to the Chancellor.
2. House Price inflation increasing to 10%. Despite recent rises in interest rates, it doesn't appear to have stopped the buoyant housing market. However, much of this increase in prices stems from a shortage in supply.
3. The old RPI measure of inflation is even higher at over 4%
   

Why Interest rates in UK may have now Peaked.

• Inflation is forecast to fall.
  Recent rises in inflation were due to cost push factors such as rising energy prices. With gas prices now falling from a temporary peak, this is likely to push inflation back within target.

• The economy is not in a boom and bust situation.

With economic growth of around 2.6% it is very close to the long run trend rate. This means there is little scope for inflationary pressure from growth constraints.

• The exchange rate has been very strong.

Against the dollar it has reached $2 to £1. The strong exchange rate helps to reduce inflationary pressures. If interest rates continue to rise, it will cause further problems for hard pressed exporters.

• High levels of debt in the UK:

This mean that small increases in interest rates will have a big effect. Even a quarter % rise in interest rates adds £14 onto a £100,000 mortgage. With mortgage interest payments accounting for a record % of disposable income, interest rates will start to have the desired effect soon.

• Time Lag of interest rate rises.

Interest rates have been increased 4 times since last summer, it seems they have had little impact on reducing inflationary pressures. But, it is estimated that interest rate increases take 18 months to have a full effect, therefore, in the coming months previous interest rate rises will start to have an effect.


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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.