“To fix or not to fix” – trends and expectations for interest rates

After 10 years without a rise, the Bank of England finally increased interest rates in November 2017. In early February 2018, the Bank said that rates were likely to rise faster than previously expected due to a strong economy and inflation.

Indeed, inflation stuck at 3 per cent in January rather than seeing an anticipated fall, adding more weight to an imminent rise

A Reuters poll shows that 32 out of 57 economists tipped the Bank Rate to rise in May following the more hawkish tone in the recent Inflation Report and rate decision commentary.  Meanwhile, a prominent member of the Bank of England monetary policy committee has said that a pick-up in wages and an increase in household debt meant the economy was ‘ready for somewhat higher interest rate.

Historically, rates have varied around the 5% mark.  And it is at this level that the bank (and government) feel more comfortable.  Why?  Because it gives more room for manoeuvre and rate reductions to counter a downturn.  Rates permanently near zero are not regarded as a healthy state for savers – or the economy in general. So, it seems entirely possible that rates will gradually creep up over the next few years as the authorities try to unwind the dovish financial policy maintained over the years following the recession. Any bad economic or political news could stave off or even reverse this trend of course, but there is no doubt that in the longer term the desire is for higher rates.

The Bank of England in their latest inflation report it suggested that the new ‘normal’ for interest rates in this cycle has been judged to be about 2 per cent, although whether they get there before a recession remains to be seen.

So, what of fixed rates?  Fixed rates are determined by the cost of “Interest Swap Rates” in the City, the price of which underlies the cost of fixed rates offered by lenders. Below is a table of approximate swap rates for various terms popular with borrowers, as at 6th February: –

Year(s)  Current Rate
1 0.696%
2 0.921%
3 1.079%
5 1.300%
7 1.438%
10 1.579%

It is noticeable that these swap rates have roughly doubled over the last year or so – the lowest point being in late 2016 when the ten-year rate was as low as 0.75%!  Even so, the current rates are still low on a historical basis, and the five-year rate is still less than the (still dovish) assumption of a new norm of variable rates of 2%.

The benefit of fixed rates is to guard against the unexpected and provide predicable debt servicing costs.  Lenders often allow more debt/higher loan to values when a fixed rate is used – a reflection of their opinion of lower risk to the borrower, and therefore the lender.

There is always the possibility that variable rates don’t go up and instead reduce again, which would mean that a fixed rate costs you more than anticipated (in context of what a variable rate would have been).

Lenders rates of course have a margin added to both variable rate and the swap rates to establish their actual rates charged.  But the differential between lenders actual fixed and variable rates is roughly the same as between Base rate and the various swap rates.

With the 5 fixed rates presently at a premium of c.0.8% to variable rate, and the potential for further modest rate base rate rises, the benefits of a fixed rate should not be overlooked – if for no other reason than to guard against unexpected changes to sentiment rather than to guard against what is expected to happen!

If you or your clients would like to review your current arrangements on Commercial Mortgages or Buy to Let Portfolios we’d be only too happy to assist.