Inflation remained unchanged in January, and is expected to reach the central bank’s target of 2% by spring. The Bank of England has also held interest rates at 5.25% since August 2023. Now that the UK economy has entered recession, will rates soon start to fall?
The CPI measure of inflation was at 4% in January, unchanged from the month prior and far lower than a year ago. With wage growth slowing more than expected and the economy now in recession, speculation has been rife that the Bank of England will start cutting rates sooner.
If you have a fixed-rate mortgage deal coming to an end soon, or you’re on a standard variable-rate or tracker mortgage, you’ll be keeping a keen eye on where it will head next and when.
In this article, we cover:
- When will interest rates fall?
- Why have interest rates been rising?
- How do higher interest rates affect inflation and mortgages?
- What help is there for mortgage customers?
If you’re looking for a new mortgage deal, and want to see the kind of rates on offer, try our mortgage comparison tool*.
When will interest rates fall?
Most analysts think that interest rates have peaked, and will soon start to fall.
The Bank will lower the base interest rate to 3% by the end of 2025, according to analysis by research firm Capital Economics, forecasting the first rate cut for June this year. This is more optimistic than projections from Berenberg Bank that say rates will fall to 4% by the end of next year.
However, it’s worth noting that at its last meeting on 1 February, there was a three-way split on the MPC: six voted to hold the base rate at 5.25%, two for a rise and one for a cut. This is the third time in a row for a split vote – and indicates rates may not soon start to fall.
“Hints of change ahead could be found in the MPC’s split decision, with sixin favour of holding the status quo, two taking a hawkish stance to raise the Bank Rate by 0.25 percentage points and oneadopting a dovish stance and calling for a rate cut,” says Alice Haine, Personal Finance Analyst at Bestinvest by Evelyn Partners.
She adds: “This is a slight shift in stance from December’s 6-3 voting pattern when six voted to leave rates unchanged and 3 voted for a quarter-point increase. Financial markets have been betting on a string of rate cuts this year, with some analysts expecting changes as early as May but, for now, the BoE is sticking with its cautious stance, stressing it remains determined to keep inflationary pressures at bay.”
Laith Khalaf, head of investment at AJ Bell, says: “The mixed outlook from the Bank’s interest rate committee will probably act as a brake on the fall in short term interest rates that we’ve seen in the last couple of months. And put upward pressure on mortgage market pricing.”
The Bank’s governor, Andrew Bailey, has repeatedly indicated rates will remain where they are for some time. December’s inflation rate increase, while small, could validate his concerns, and lead the committee to keep rates at their current level for longer.
The latest Monetary Policy report says rates are expected to remain around 5.25% until autumn 2024 and then decline gradually to 4.25% by the end of 2026.
The future of interest rates depends significantly on how quickly inflation drops – while wage growth and unemployment also play a factor.
The UK economy has also just entered recession, and the Bank of England may take this into account when making their next interest rate decision. By lowering interest rates, they could stimulate the economy by making it cheaper to borrow money. Find out more about the recession.
Why have interest rates been rising?
Interest rates have shot up in the UK since 2021 as the Bank of England has attempted to get runaway inflation under control.
The main factors pushing up the cost of living have been rising energy and food prices and a shortage of workers which has led to higher wage costs for businesses. To afford these extra costs, many companies have raised the prices of the good and services that they offer.
One of the roles of the Bank of England is to keep the annual CPI rate of inflation at a target of around 2%. The Bank’s Monetary Policy Committee (MPC) can do this by raising (or cutting) interest rates. It hikedthe base rate 14 consecutive times from December 2021 to a 15-year high of 5.25% in August 2023.
Inflation has fallen sharply from its 41-year-high of 11.1% in October 2022. It rose slightly in December 2023 from 3.9% the previous month to 4%, but then remained at this level in January 2024. Where it heads next will have a big impact on where interest rates will go. But it is not the only measure that the Bank of England looks at when setting rates.
Why has the Bank of England held the base rate at 5.25%?
There are several key reasons cited by the central bank for maintaining them at their current level:
- Despite being double the 2% target, inflation has fallen significantly, which was the main objective of raising the base rate
- Increasing the base interest rate can slow an economy down, too much and it falls it into recession
- It takes time for the rate rises to be fully felt in the economy. The Bank needs to wait to see how effected the moves have been
How do higher interest rates affect inflation and mortgages?
When interest rates rise, the cost of borrowing money becomes more expensive. On the flip side, banks tend to offer better rates on savings accounts. The hope is that we will spend less and save more.
If there is less demand for goods and services, prices will eventually fall too, thereby lowering inflation.
The Bank is particularly concerned about something called the wage-price spiral. Unemployment is low in the UK as businesses struggle to find workers to fill many vacant roles.
In this scenario, employees have more power to demand higher wages to keep up with the rising cost of living. To pay for a larger wage bills, businesses increase the price of their goods and services, keeping inflation higher for longer. Find out more about why wages are currently rising.
How much can raising interest rates impact inflation?
There is only so much that the Bank of England can do to influence inflation, especially given the reasons why it is so high in the first place.
For example, there is nothing the central bank can do about pandemic supply shortages, wars or droughts. But it can try to impact wages and consumer spending in this country. Nevertheless, the its sustained and aggressive interest rate hikes appear to be a major driver of the fall in inflation.
The annual inflation rate for January was 4%, unchanged from December but a major fall from its level of 10.5% a year prior.
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How could higher interest rates impact the housing market?
The average two-year fixed mortgage rate is currently just above 5.7%. It has come down substantially from a high of 6.86% in July 2023 but is a long way from the 2.17% it was in June 2021.
The leap in mortgage rates means many millions of homeowners face far higher monthly costs. The fixed-rate deals of 1.6 million households will come to an end in 2024 and nearly all of them will see an increase in monthly repayments.
These significant added costs may force some mortgage holders to sell their homes if they can no longer afford the monthly payments.
It’s also becoming much more difficult for prospective first-time buyers to get on the housing ladder, as heightened mortgage costs make affordability checks tougher to pass.
“Based on our current economic assumptions, we anticipate a gradual rather than a precipitous decline in house prices,” said Kim Kinnaird of Halifax Mortgages.
House prices falling across the board could mean millions of households end up in the choppy waters of negative equity.
Read more: What’s happening to house prices?
What help is there for mortgage customers?
The government has spoken to mortgage lenders, and instructed them to provide greater support for their mortgage customers. Customers can temporarily switch to interest-only payment plans for up to six months while interest rates stabilise. This will not affect on their credit score.
However, it’s worth noting that if you take this step, you won’t be clearing your mortgage balance for the duration of this period. Your mortgage will therefore end up more expensive in the long run. Find out more about asking your lender for help.
Some homeowners or those that have bought a shared ownership property may also qualify for Support for Mortgage Interest (SMI). This is a government loan that goes towards the interest on your mortgage repayments or loans that you have taken out for certain home repairs and improvements, up to £200,000.
You will need to repay the loan with interest when you sell or transfer ownership of your home (unless you’removing the loan to another property). The interest rate used to calculate the amount ofSMIyou’ll get is currently 3.16%.
To be eligible, you need to be in receipt of a government benefit such as Universal Credit or Pension Credit.
Our consumer rights expert explains your options if you’re struggling to make mortgage repayments.
What’s happening to savings rates?
Savings rates tend to follow what happens with interest rates now and predictions for the future.
With interest rates being held by the Bank of England, and expectations that the next movements will be down, savings rates have been falling.
Check out the top interest rates on savings accounts at the moment.
How do ‘higher for longer’ interest rates affect investments?
High interest rates for a long period of time are not good for the value of most of your investments. It reduces the amount of money flowing through the financial system that can find its way into investable assets. This weighs down prices by reducing overall demand in the market.
The impact is compounded because people expect asset prices to be held down as rates go up. This means they sell off some of their existing investments, or stop buying new assets.
Higher interest rates also tend to translate to higher returns on savings accounts. This can make investing in stocks, or other assets that carry risk, seem less attractive on a relative basis than when rates are low.
Central banks are aware of the impact higher rates have on investments. In fact they intend it to be the case. By holding down the value of assets they reduce the amount of money people have and this causes them to cut back on discretionary spending. This in turn helps reduce inflation, which is the central goal of raising interest rates in the first place.
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