Another hold for bank rate – with many more to come

With the £125bn already committed to Quantative Easing (QE) by the MPC due to be spent by the end of the summer but bank lending, especially for mortgages, still woefully inadequate, agreeing to the further £25bn approved by the Treasury is a no brainer. What probably provoked more discussion, particularly bearing in mind there is no UK history of QE to learn from, was whether to ask the Chancellor to increase the size of the QE facility. However, a strong argument for doing so is to enable the MPC to have some ammunition available, should it decide to use it, to avoid the committee running out of options if it considers further easing is still required (which it probably will).

A clear indication of the distress in the mortgage market can be gleaned from a comparison of the movement in swap rates over the last month with the change in the cost of most fixed rate mortgages. Taking the five year market as an example the rate for five year swaps fell from 3.76 percent in June to 3.49 percent in July. However, the cost of fixed rate mortgages rose steadily throughout June and has not fallen back since. There was a whole raft of five year fixed rates available well below five percent at the beginning of this period but most are now well above.

For example at the beginning of this period Britannia offered the market leading five year fix, with a rate of 4.44 percent, a fee of £1,149 and a maximum LTV of 60 percent. Likewise Northern Rock and Abbey both offered five year fixes at 4.69 percent with a £999 fee a month ago, the former to 65 percent LTV and the latter to 70 percent, but the comparable rates from these lenders are 5.29 percent and 5.79 percent, although the maximum LTV on the Abbey fix is slightly higher at 75 percent.

Thus over the last month spreads on five year fixed rates over the cost of funds have increased by about one percent. This is not a sign of a healthy market. Activity in the property market is historically still very low but mortgage lenders have struggled to satisfy even the small increase in demand resulting from the recent modest increase in purchase activity. Fixed rates were initially increased a month ago to reflect an increase in swap rates but have since not only not fallen back in line with swap rates but have risen further as lenders respond to increased demand by pushing rates up even more to deter business. This of course has the welcome benefit for lenders of increasing gross margins, which were already the highest they had enjoyed for years.

As early signs of some recovery in the economy are now looking less certain the likelihood of Bank Rate remaining low for longer is increasing, whereas the medium and long term fixed rate markets are now discounting a relatively early increase in rates. There has been little change in the cost of tracker mortgages over the last month and as a result the initial gap between the cost fixed rate and tracker mortgages has widened considerably. For anyone who believes Bank Rate will remain low, say under two percent, for at least three years there is now a strong argument for considering a tracker mortgage in preference to a fix, ideally retaining the ability to switch to a fixed rate if rates on fixes fall back. This will mean either buying a tracker with no, or low, early repayment charges (ERC) or one which offers a droplock option, allowing a switch to a fix without incurring the ERC.

Ray Boulger
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