What impact would a rate rise have on mortgages?

Andrew Wishart, a property economist at Capital Economics, says the research company has forecast increases in the base rate, but not until spring.

“Our forecast is that we’ll see the first increase in bank rate to 0.25 per cent in May next year, and then to 0.5 per cent in 2023.

“The reason we think it’s going to be a bit longer is because the furlough scheme only ended at the end of September and that potentially has the possibility to change the picture of the labour market.

“Shortages in the labour market and strengthening underlying wage growth are one of the main reasons the Bank of England thinks that it might need to raise interest rates. So that’s the reason for the timing of our forecast.”

Wishart also says that a modest increase in the base rate would not push mortgage rates up by much, if at all, noting improvement in banks’ risk appetite, which he expects will likely offset any small rise in the base rate.

“It’s important to note that mortgage rates are basically where they were when Covid-19 first hit, and when bank rate was at 0.75 per cent. They didn’t really drop with the drop in bank rate.

“And so in terms of our forecast for a modest rise in bank rate, we suspect that as banks’ risk appetite improves – and has improved – because of the recovery we’ve seen so far, and because at the start of the pandemic there was a lot of concern about falling house prices, which has now been resolved (we’ve seen very strong house price growth), we suspect that the gap between the spread of mortgage rates over bank rate could narrow and mean that mortgage rates don’t rise much, if at all.”

According to Wishart, mortgage lenders’ interest margins improved during the pandemic to account for the perceived increase in lending risk at the onset, amid uncertainty over the economy and house prices.

He continues: “But as that’s receded and we’ve come out of a pretty benign labour market outcome and house prices doing very well, and all the near-term indicators suggesting that they will continue to do well, banks are willing to accept a narrower margin again, so they’ll probably absorb much of the increase in their financing costs due to rising interest rates, as long as those rises in interest rates aren’t too big.”

Likewise, Andrew Gall, chief economist at the Building Societies Association, says he believes the Monetary Policy Committee will take a ‘wait and see’ approach, also citing the end of the Coronavirus Job Retention Scheme.

And while mortgages tend to become more expensive following a base rate rise, Gall predicts that recent competition, which has seen some mortgage rates fall below 1 per cent, will remain.