What Is The Outlook For Interest Rates?

UK interest rates were held at a record low for the 25th month in a row last week, which has posed questions to contractors who currently have a mortgage or are thinking of taking one. How long can this last? Should I assume rates will go up and take a 5 year fixed rate, or gamble that they will stay low and take the risk on a variable deal? Sound familiar?

There are some clues if you look at comments made by Mervyn King, Governor of the Bank of England, when he explained his outlook for the UK economy. The answer to the questions posed above is linked to one key word – inflation.

Mr King said the consumer prices index (CPI) measure of inflation would climb closer to 5% in 2011. However, he said, the Bank’s Monetary Policy Committee (MPC) believed inflation will be around target at 2% in two or three years “under the assumption that the bank rate increases in line with market expectations”.

“Interest rate futures are pricing in a first 0.25 percentage point rise by Q4 this year, and another every three months for the next two years or so”, said Philip Rush, economist at Nomura. That would signal a 0.25% increase by the end of 2011, and a further 0.75% by the end of next year.

But what about prospects for the base rate beyond 2012? Most economists have differing views at this point, so I will offer an opinion at this point and nothing more. There is a strong argument that says rates do not necessarily have to go back to pre-recession levels for a booming economy, an argument I agree with. A base rate of circa 3% could be enough to sustain an economy that has put the worst post war economic crisis behind it. Factors affecting inflation in the short term, such as oil and commodity prices as well as austerity measures applied by the current government, should fall away in the short term, allowing for a more realistic appraisal of inflation. That figure, in my opinion, will be between 2 – 3%; easing upward pressure on the base rate.

Being a realist about party politics, I predict the current government will generate a “mini-boom” in 2015 prior to the next general election via fiscal policy; therefore assuring a Conservative led government for another 5 years. The impact on interest rates after that is a topic for another day.

In short, contractors should look at their own affordability requirements when considering their new mortgage. Predicting what to do based upon base rate movement is educated guesswork at best, so factors like potential gaps in contract and available savings should play more of a factor in the decision to fix or not to fix.