On 19 June, the Office for National Statistics (ONS) published its latest Consumer Price Inflation data, which showed that the Consumer Prices Index (CPI) returned to the Government’s 2% target.
CPI rose by 2% in the 12 months to May 2024, down from 2.3% in the 12 months to April, its lowest level since April 2021. The rate of inflation was also well below its recent peak of 11.1% in October 2022, which was the highest rate in over 40 years.
The biggest downward contributions were from food and non-alcoholic beverages, recreation and culture, and furniture and household goods. Notwithstanding, services inflation remains sticky with prices still increasing at an annual rate of 5.9%. This is significant because the Bank of England have said that they would like to see services inflation ease before they cut the base rate. That said, all forecasts point to a cut when the Bank next meets on 1 August.
Why is low inflation important for mortgages? The Bank of England has a mandate to keep CPI inflation to 2% over the medium term and it does this by raising or lowering the base rate (interest rates) to control the money supply. But this doesn’t tell the full story. Although the base rate has remained unchanged since August 2023, Sonia (Sterling Overnight Index Average) swap rates, which directly influence the pricing of fixed-rate mortgages, have already started to fall in anticipation of future rate cuts.
Why is Sonia important? Mortgage lenders borrow money from their funders on floating rates, but 74% of mortgages in the UK are fixed rate (UK Finance), so that requires lenders to hedge against interest rate changes during the fixed-rate period (typically two or five years in the UK). Sonia swap rates are fixed rates that can be exchanged for floating rates to hedge against potential changes. Higher Sonia swap rates means higher fixed mortgage rates, as lenders need to cover the increased cost of hedging, and vice versa.
So, what’s been happening with Sonia swap rates and how is this affecting the repricing of fixed-rate mortgages? It is important to note, unlike the base rate, Sonia swap rates change daily to reflect market expectations about future interest rates. This is why mortgage lenders continue to reprice fixed-rate mortgages despite the base rate being unchanged in nearly a year. With market expectations strengthening for lower inflation and interest rates, the two-year Sonia swap rate has fallen to 4.425% from 4.676% a month ago, and the five-year to 3.861% from 4.102% (Chatham Financial). As a result, HSBC, NatWest, and Barclays have all announced cuts to the cost of fixed-rate deals with other mortgage lenders expected to follow suit.
Whether fixed-rate mortgages continue this downward trajectory or not depends very much on the data and market expectations for future inflation and interest rates. We’ll know more when the ONS releases its next CPI data on 17 July.
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