Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
Ed Monk: "Choosing when to cut rates is like trying to catch a falling knife"
Following the latest interest rate announcement, Ed Monk, associate director at Fidelity International, said choosing when to cut rates is like trying to catch a falling knife - moving either too early or too late is likely to be painful.
“The hawkish tone from the BoE in keeping rates on hold will disappoint households, investors, and the government. All could do with some relief from higher borrowing costs, but the Bank’s words today indicate it may be some months before it agrees. Still only one rate-setter on the MPC was willing to vote for a cut now.”
As Ed mentioned, the recent interest rate announcements may well disappoint households, particularly mortgage holders and those looking to get on the property ladder.
According to Fidelity analysis, last November, the average 2-year mortgage rate was around 4.9%. Since then, it has gradually fallen. However, by mid January, mortgage rates began to climb once again. The latest 2-year mortgage rate is around 4.5%.
The average 5-year mortgage has seen a similar pattern. Last November, the average rate was around 4.7%. This slowly climbed down to 3.8%. But in mid February, there was a significant jump to the 5-year rate, to 4.3%. Given that mortgage rates are closely entwined with the direction of interest rates, elevated mortgage rates only reinforce the idea of a higher for longer rate environment.
Although higher for longer rates are good news for cash savers. Like mortgage rates, cash saving rates have followed a similar pattern. Fidelity analysis shows the level of interest cash accounts offer remain pretty consistent. Last November, easy-access cash accounts offered 5.2%. Between then and now, this has only fallen to 5.1%.
However, 1-year fixed term savings accounts have seen a bit of a rollercoaster. Last November, they offered around 5.9% interest. Since then it took a dip, hitting 5.1% in mid-January, but it has seen some recovery. The latest rate on offer is around 5.2%.
Since the MPC’s last meeting, it has been a bit of a mixed bag. According to the central bank, inflationary pressures are easing in the US and euro area, but material risks remain present in the Middle East,including disruption to shipping through the Red Sea.
Looking at the latest UK economic data releases, UK gross domestic product (GDP) is expected to grow during the first half of the year and business surveys remain consistent with an improving outlook for activity, according to the BoE. The labour market has continued to loosen but remains relatively tight by historical standards. Wage growth remains elevated, but it has moderated across a number of measures.
Inflation is expected to meet the Bank’s 2% target in coming months. But Ed said that against this backdrop, rates at their current level will appear even more painful.
UK inflation falls to 3.4%
UK inflation saw a fall in February to 3.4%, down from 4% in January, marking the lowest level of inflation in over two years.
According to the Office for National Statistics, the fall was driven by an easing in food price growth, while the largest rises came from housing and household services, and motor fuels.
The latest inflation figure certainly paints a more upbeat picture and will no doubt spark traders’ expectations that the Bank of England may cut interest rate cuts this summer.
Following the inflation release, the UK two-year gilt yield, which is sensitive to interest rates, saw a fall from 4.2% to 4.1%. Meanwhile, the FTSE 100 fell by 0.25%.
Tom Stevenson, investment director for personal investing at Fidelity International, said: “The significant - and slightly bigger than forecast - fall in inflation from 4% to 3.4% in February was expected and welcome. It provides a helpful backdrop to tomorrow’s rate-setting decision by the Bank of England.”
Inflation is likely to continue falling through the spring as cheaper gas and electricity from April drives household energy costs lower, he said.
“The UK has been an outlier, as inflation has fallen back more slowly than our peers. But the latest data shows us falling back in line with the US and Europe. It provides substance to the government’s claim, at the Budget and elsewhere, that the UK economy has turned the corner,” said Tom.
“The expectation remains that interest rates will stay on hold until June at least and will fall back only slowly from the current 5.25%. Inflation may briefly touch the Bank’s target in the next few months but is not expected to settle at 2% until 2026.”
“That means homeowners expecting a significant easing in mortgage rates this year face higher for longer borrowing costs. This will keep a lid on the nascent housing recovery that has seen prices stabilise in the past few months.”
As of 20 March, the average two-year mortgage is 4.55% while the average five-year mortgage is 4.3%. These rates could begin to fall in coming weeks if the shift in bank rate expectations holds.
How rates forecasts have changed
At the start of the year, markets had been pricing in several interest rate cuts by the end of the year, possibly taking the rate down from 5.25% to 4.5%, as shown in the chart.
Those expectations had edged back in January but the latest inflation data, in particular, increased the chances of a rate cut. Traders priced in a 40% chance of a first cut in June before the inflation numbers and 65% after the data was released. The probability increased again, to 75%, after the GDP data was published.1
As of 21March, the average two-year mortgage is 4.5% while the average five-year mortgage is 4.3%. These rates could begin to fall in coming weeks if the shift in bank rate expectations holds.
Current mortgage and savings rates
2-year fixed mortgage | 5-year fixed mortgage | Easy-access cash account | 1-year fixed term savings account |
|---|---|---|---|
4.55% | 4.3% | 5.1% | 5.26% |
As of 21March 2024
Dates and data to watch:
- Retail sales - 22 March
- Gross domestic product (GDP)monthly estimate - 12 April
How do rising and falling rates affect investments?
There are many ways that rate movements affect investments. Most people will be all-too familiar with the impact it can have on residential property prices, for instance.
But it can be nuanced. Consider the impact the recent rises had on growth and value stocks. Growth stocks, which had flourished in the era of low rates, faltered. Companies that are growth focused are often more sensitive to interest rates compared to value stocks. For example, Apple is a very growth focused company. This is because the value of Apple’s shares is determined by the value of all its future cash flows, discounted back to a present-day value. And because of the way investors value future growth, companies which are expected to have a lot of growth in the future are more sensitive to rate rises.
That’s why last year, when rates rose, growth stocks fell out of favour. Similarly, when rates fall, growth stocks become popular with investors. Even the rising expectation of falls was enough to spur a big rally in the "Magnificent 7"big tech growth stocks at the end of 2023.
Value stocks, in contrast, perform better when rates are high or rising. Consider BP. It will continue to generate profit and churn out dividends even if it’s in a high interest rate environment. That’s because its value is derived from the profits it makes today and its dividend-paying capacity.
Another consideration is the impact on money market funds. High rates have improved the rates of return on these funds, which are considered to be low risk. From the Select 50, the Legal and General Cash Trust is currently yielding 4.3%, for instance. Please note this yield is not guaranteed.
How rising and falling rates affect and mortgages and mortgage pricing?
Standard variable rate (SVR) mortgages and existing trackers tend to follow the Bank Rate, but the pricing of new deals is more complicated.
Banks and building societies lend money from deposits taken from customers but also from money they borrow on money markets.
Fixed mortgage deals are influenced by “swap rates”, be it two-year, three-year or five-year pricing, while variable rate deals, such as trackers are more closely aligned to changes in the yields on gilts, UK government debt bonds.
Since swap rates are based on what the markets think interest rates will be, if they rise, then mortgage lenders will increase their pricing to maintain their profit margin. If they rise too rapidly - mortgage lenders may have to pause lending or withdraw products until pricing stabilises.
Ashray Ohri, a lead on macro research at Fidelity, said that mortgage rates are inherently linked to the risk-free overnight indexed swap (OIS) rates, which reflect the expectations for the path of Bank rate in the future.
These changes steadily filter through to changes in mortgage pricing. A fall in swap rates in often followed by a fall in the rates being offered on new fixed mortgage deals, although this is never guaranteed given the many factors at play.
We hope to provide more information on swap pricing so please bookmark this page and watch out for updates.
UK mortgage borrowers’ sensitivity to rates
The UK central bank is particularly mindful of the impact rate changes have on UK consumers.
Some markets, such as the US and Denmark, traditionally have mortgage rate terms of 20 to 30 years. In Britain, Canada and much of Southern Europe, short-term deals pervade.
It means that in the UK, mosthomeowners are currently on a fixed-rate mortgage, making it the most common type of mortgage.
The Bank of England is acutely aware that millions of people will see these arrangements, some fixed at rates below 1%, coming to an end in the coming years, with those borrowers compelled to take far higher rates.
As of 20March 2024, the average two-year mortgage is 4.55% and the average five-year mortgage is 4.3%.3
A peak in savings rates?
Savings rates, of course, are also part of this maelstrom of market pricing. The change in forward market pricing may put pressure on banks to withdraw some of the best buys on offer. Although again, these markets are volatile, and nothing is certain. Given inflation has fallen, saving rates now exceed inflation which currently standsat 3.9%.
As of 21 March 2024,the best return savers can currently get on easy-access cash accounts is 5.1%4although higher rates are available if you tie money up for periods.
The best fixed-term savings account offers 5.26% if you lock in for a one-year fix.
And finally… annuity rates
Aside from increased savings rates, another silver lining of the recent surge in Bank Rate has been improved annuity rates. With annuities, you hand over a lump sum and received an income, often inflation-linked, for the rest of your life. These rates were appallingly low in the era of low rates but have enjoyed a renaissance. Annuity pricing is influenced by the yields on gilts. The 10-year gilt yield hit a high above 4.5% in early September and has since fallen to around 4.13% (20March2024). If you sign up to our Pulse alerts, you'll be the first to know when forecasts move.
The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one ofFidelity’s advisers or an authorised financial adviser of your choice.
