Cost of fixed-rate mortgages set to fall as UK inflation outlook brightens

Interest rates on five-year fixed mortgages are set to drop below 4 per cent after the Bank of England suggested inflation may come under control sooner than expected, according to brokers.

The central bank on Thursday raised its benchmark interest rate by half a percentage point to 4 per cent, in response to high inflation. After 10 upward moves since December 2021, the BoE suggested rates may have peaked.

Lenders, who set prices for their fixed mortgage deals using financial market expectations about future base rate movements, had already priced in the latest tightening of monetary policy.

But after the BoE’s meeting on Thursday, market expectations of future rate increases dropped further. Traders anticipate one quarter-point rate rise in March, and that the BoE will then begin loosening monetary policy by the end of the year.

The change in expectations in the overnight index swap market, which follows BoE decisions, suggests the average central bank rate over the coming two years will be 3.75 per cent, down from 4.34 per cent at the start of January. The average BoE rate over the coming five years is now 3.21 per cent, down from 3.93 per cent in January.

Ray Boulger, manager at broker John Charcol, said he expected lenders to move quickly to improve their five-year fixed deals, where the lowest rates are currently around 4.2 per cent.

“There’s a clear ability in the market now to offer a five-year fixed rate at sub-4 per cent and the first lenders to do that will get some good marketing from it,” he added.

Demand for fixed deals is also likely to grow as interest charges on variable-rate mortgages rise in response to monetary tightening by the BoE.

After the market turmoil that followed the then prime minister Liz Truss’s “mini” Budget in September, rates on many fixed deals soared above 6 per cent. It made variable rate loans a viable alternative for borrowers.

However, fixed deals have dropped in price in recent weeks as stability returned to markets. As rates on variable deals rise, brokers said more borrowers would return to the certainty of a fixed monthly payment on their mortgages.

The average rate on two-year fixed deals has dropped to 5.43 per cent, from 5.77 per cent at the start of the year, according to finance website Moneyfacts.

Simon Gammon, managing partner at broker Knight Frank Finance, said borrowers would welcome a significant drop in the cost of two-year fixed mortgages.

He added the decision on whether to take out a five-year fix had become more challenging as mortgage rates fall.

“At the moment, five-year fixed rates are cheaper than two-year fixed rates,” said Gammon. “But a lot of people with uncertainty and those who don’t quite know when to fix are actually more interested in the shorter term deals.”

Rising mortgage expenses are a major concern for homeowners in the cost of living crisis, and experts have warned of an impending “payment shock” as borrowers who took out fixed deals in the era of ultra-low interest rates face refinancing at much higher interest charges.

More than 1.4mn households face higher charges this year as their fixed deals come to an end, according to data last month from the Office for National Statistics.