UK interest rates will peak at 5.5% next month as Bank of England policymakers try to minimise the impact of higher borrowing costs on the UK economy and avoid a prolonged recession, economists predict.
A fresh poll of economists by Reuters suggests the Bank will approve a 15th consecutive increase in interest rates at its next meeting on 21 September as part of efforts to combat price inflation, which is still more than three times higher than its 2% target. All but one of the 62 economists surveyed said they expected the Bank’s base rate to rise by a quarter of a percentage point next month, taking rates from 5.25% to 5.5%. The only outlier expected a half-point hike, which would take rates to 6%.
The Bank has been raising rates at a clip in an effort to lower surging inflation, which peaked at 11.1% last October and has since eased to 6.8% in July.
The Reuters poll shows that economists expect inflation to average at 6.8% this quarter, before falling to 4.7% in the fourth quarter. It is not forecast to drop below the 2% target until at least 2025.
However, policymakers must weigh the consequences of further rate hikes. Higher borrowing costs have weighed on the housing market – as consumers avoid costlier mortgages – and private sector activity across the UK.
The latest monthly business health checks, known as the purchasing managers’ index (PMI), showed weakness in the UK services and manufacturing sectors and the poorest performance for both industries since the Covid lockdown in early 2021. Companies said they had struggled amid Britain’s cost of living crisis, lower export demand, fears over the economic outlook, and higher interest rates. It has led some experts to predict that the UK will slip into a recession in the third quarter.
James Smith, a developed markets economist at ING said "the August [Bank] meeting began to lay the ground for a pause, I think the fact [that] the Bank is now finally admitting [its] policy is restrictive […] it is now a turning process to convince markets [that] rates are going to stay high for quite some time. It comes down to the data, ideally they would like to stop hiking, given rates are restrictive … By November, the Federal Reserve will be done hiking and potentially also the European Central Bank, so it is a risk being seen as the last hawk standing somewhat unnecessarily.”
Inflation slows to 6.8% but further interest rate rise likely
- Inflation in the UK dropped to 6.8% in the year to July from 7.9% in June
- It's the second month in a row that the rate of inflation - how quickly prices are rising - has dropped sharply, and it's now at a 15-month low
- The latest figure was driven by a reduction in the energy price cap and food costs rising less rapidly - particularly milk, bread and cereals
- But UK inflation remains stubbornly high overall compared to many other nations, and well above the Bank of England's target rate of 2%
- The rising costs of hotels, air travel and rents are some of the main things keeping inflation high, according to the Office of National Statistics
- As a result, the Bank of England is expected to raise interest rates again next month in an effort to bring inflation down
Experts believe the Bank of England unlikely to veer away from hiking the base rate, however the UK’s annual inflation rate fell further to 6.8% in July, down from 7.9% in the previous month, but some industry experts believe the Bank of England (BoE) is not yet ready to end the streak of consecutive base rate hikes.
The latest consumer price inflation (CPI) data published by the Office for National Statistics (ONS) on Wednesday also showed a 0.4% decrease in CPI on a monthly basis.
Matthew Corder, deputy director of prices at the Office for National Statistics said “Inflation slowed markedly for the second consecutive month, driven by falls in the price of gas and electricity as the reduction in the energy price cap came into effect. Although remaining high, food price inflation has also eased again, particularly for milk, bread, and cereal. Core inflation was unchanged in July, with the falling cost of goods offset by higher service prices.”
Ben Thompson, deputy chief executive at Mortgage Advice Bureau, said "that while July’s inflation fall is a firm sign that the headline rate is moving in the right direction, salary rises have thrown up yet another conundrum for the Bank of England. Wages have grown at a record level to 7.8% and are now higher than current inflation at 6.8%,” Thompson pointed out. “Inflation dropping back opens the door for the BoE to press pause on rate rises, but record wage growth keeps potential hikes firmly on the table. Inflation being below average wage growth could mark a turning point in the cost-of-living crisis, and potentially signal good news for mortgage customers, with lenders already reducing their rates and more manageable payments becoming a reality.”
Adam Oldfield, chief revenue officer at Phoebus Software, however, believes that "while inflation fell below 7% in July, the Bank of England is highly unlikely to veer away from its current path, and another base rate rise is likely to be on the horizon. For the housing market and mortgagers in particular, this would be another blow, especially when we are already seeing arrears increasing,” he said. “The recent rate cuts on fixed rates has given a bit of hope for some, but there seems no respite for those that now find themselves on SVRs. Lenders will need to be canny to meet their lending quotas in the last few months of the year as borrowers face the dilemma of whether to fix now or wait.”
Simon Webb, managing director of capital markets and finance at LiveMore, agreed with Oldfield, saying that "despite the latest fall in the inflation rate, there is still a long way to go to reach the government’s 2% target. Core inflation is now higher than the main figure at 6.9%, which excludes the food and energy prices,” Webb noted. “Along with yesterday’s announcement of wages growing by a record 7.8% in Q2, it looks likely the next base rate decision will be another upward hike.”
For Lily Megson, policy director at My Pension Expert stated "the relief that falling inflation and increased wages have brought to Britons might only be temporary. Indeed, inflation’s persistent grip on people’s finances is not set to loosen any time soon,” she said. “The approach of just ‘waiting until inflation comes under control’ is not fit for purpose. The government must look to other areas of support to help people better understand their financial circumstances. Arguably, the better people feel more supported in their financial situation, the more in control they will feel of their situation – a feeling many people will value during this economically volatile period.”
Third of UK homeowners take extra work for repayments
New data released by the digital staffing platform showed that 30% of homeowners due to remortgage in the next 12 months were already making extra money by doing extra shifts or taking on side hustles — including temporary work — to boost their savings.
Results of Indeed Flex’s survey of 2,000 Britons also revealed that three in 10 of those taking on extra work were from 25 to 34 years old – an age group that is typically newer to the housing market, meaning repayment rates are likely to be higher compared with older owner-occupiers. More than a tenth, or 11%, of those aged between 55 to 64 are pursuing additional employment to cover increased repayment costs.
More than half, or 54%, of UK mortgage holders were preparing for financial changes in the next 12 months by also cutting back on non-essential spending, including takeaways and holidays, while a third said they were spending less and saving more.
According to UK Finance mortgage data, 800,000 fixed rate mortgage deals are set to expire in the latter half of 2023, along with 1.6 million in 2024. With borrowing rates rising, the Bank of England estimated that households could see their outgoings increase by an average of £220 a month when they renewed.
“Facing financial realities head-on can be challenging, but ignoring them is likely to prove costly in the long run,” commented Novo Constare, chief executive at Indeed Flex. “While those with mortgages expiring this year cannot escape repayment increases, a substantial number are actively seizing control of their finances and trying to get ahead of the increase in their outgoings.”
When will UK interest rates come down? Bank of England base rate forecast - what it means for cost of living
While the Bank of England expects inflation will ‘fall sharply’ in 2023, markets are still expecting further interest rate hikes. In under three weeks’ time, the Bank of England’s Monetary Policy Committee will meet to discuss UK interest rates.
Analysts expect the group of central bank employees and independent economists to raise the base rate - the mechanism that sets how expensive it is to borrow money across the economy - to 5.5%. This would mean it is at its highest level since the 2008 financial crisis.
Whilst homeowners on fixed rate mortgages will be insulated from the latest hike - for now, at least - those on tracker and standard variable rate products will see their monthly costs rise. Things could get even pricier for people in this situation if the next inflation announcement does not live up to expectations.
Although headline inflation, as measured through the Consumer Prices Index (CPI), slowed last month, there was bad news for services and core inflation. The rate of price hikes for services increased, while the core figure remained unchanged month-on-month. Any further bad news could lead to a repeat of the mortgage market jitters we have seen so far this summer.
The big question is whether we will see the Bank of England interest rate begin to fall anytime soon. But when might this happen?
The good news in the longer-term is that most economists expect interest rates will decline. This is because inflation, which the Bank of England tries to control by using its base rate, is expected by the central bank to halve by the end of 2023 before falling below its target rate of 2% between 2024 and 2026.
But the Bank has also sounded the same cautionary note on several occasions, warning that there is a possibility inflation in wages and daily costs “may take longer to unwind than they did to emerge” - in other words, inflation could be ‘sticky’. We have already seen evidence of stickiness in wage growth statistics (which imply that consumer purchasing power could be about to move in line with inflation) and core inflation.
In its global economic outlook published in April, the International Monetary Fund (IMF) said current high interest rate levels were likely to be “temporary” and will be reduced “when inflation is brought back under control”. For advanced economies, like the UK, the IMF said interest rates should fall “back towards pre-pandemic levels” as a result of several factors, including an ageing population (older people tend not to create as much demand in the economy).
The key word in that sentence is ‘towards’. By using it, the IMF is suggesting we might not see the record low interest rates of the 2010s, which consistently remained below 1%.
Another key reason for why interest rates are very likely to come down at some point is the economy. High interest rates can restrict economic activity as they make the cost of borrowing more expensive - loans being key for businesses if they want to expand. While falling into a recession is seen by some economists as a potential route out of the inflation crisis, politicians argue it would prove too damaging to living standards. But Jeremy Hunt appears to be resigned to the fact that a recession may be on the horizon - even if it means Rishi Sunak does not meet his pledge to grow the economy.
While we know the base rate will almost certainly come down at some point, the big question is when.
The Bank of England has left the door open to further interest rate hikes at each of its interest rate-setting meetings. So, the wording it uses at its next announcement in September will be pivotal, given many experts predict it will mark the peak of the current rates cycle. If it does continue to leave the door open, the effect may be a ploy to inject uncertainty into the business world, which in turn could reduce economic activity and therefore, inflation.
But Huw Pill, the central bank’s chief economist, has suggested he will be voting to keep things where they are at the next MPC meeting. Speaking at an event in South Africa on Thursday (31 August), he warned another rates rise could cause “unnecessary damage on employment and growth”. He also quashed any hopes that he would be voting for a drop in rates anytime soon, saying: “At present, the emphasis is still on ensuring that we are – in the words of the MPC’s last statement – sufficiently restrictive for sufficiently long to ensure that we have that lasting return to target.”
If the next meeting does turn out to see a new peak, it is still unlikely to mean the base rate will fall back anytime soon. The Bank’s own forecast from August does not foresee the rate dropping until mid-2024 - indeed, its market analysis suggests it could still raise it to 6%.
Even if it doesn’t go this far, the base rate is expected to remain above 4% until at least the end of 2026 - more than four-times above the typical rates from the 2010s. In other words, don’t expect your mortgage to go back to where it was before the Covid pandemic.
As for commentators’ predictions, analysts at independent consultancy Capital Economics have previously predicted a “plateau” for the Bank rate once it hits its peak. Investment platform Saxo has predicted the rate will not fall until May 2024 - albeit with the caveat that improving inflation data could change the picture. Samuel Tombs at Pantheon Macroeconomics said the Bank of England’s own forecasts suggest rates are not set to fall back sharply for some time, with its commentary “broadly endorsing markets’ current expectations for only a modest reduction in Bank rate next year”.
Brokers discuss the future of the base rate
Google searches for 'when will interest rates go down' has exploded by 487% in the last 12 months, according to L&C Mortgages.
The general consensus from brokers is that the Bank of England’s latest base rate rise of 0.25% has sparked some concern amongst consumers, with many now seeking further clarity on the long-term prospect for interest rates.
Expectations
Elliott Culley, director at Switch Mortgage Finance, said "the increase in Google searches for the above question was no doubt down to worried mortgage owners hoping for further clarity before they remortgaged. We have seen some positive first steps over the last couple of weeks, better than expected inflation figures and a rise of only 0.25% to the base rate, have helped to steady the long-term expectations for the market.
While Culley said the Bank of England still suggested there were some base rate increases to come, he added "mortgage lenders seemed to have priced this in when looking at the current mortgage rates."
Lee Gathercole, co-founder at Rebus Financial Services, agreed with Culley that following positive inflation data of late, this could mean the peak of interest rates was near to being reached.
However, Gathercole said "it was expected that we may see two more marginal increases to the base rate from the Bank of England, in the near future. Therefore, I do not see the base rate dropping until next year, although it is already great to see major banks reducing interest rates in recent weeks. The good news for homeowners and first-time buyers, rates are likely to hold steady in 2024 and, by the end of next year, he believed there may be considerable reductions."
Graham Cox, founder at Self Employed Mortgage Hub, meanwhile believed "the Bank of England would slowly lower the base rate once inflation was below 5% and confidence had returned for it to reach its 2% target. The political and economic pressure to reduce the base rate would be overwhelming once inflation fell below 5%, so this might come in the last quarter of 2023, however it was more likely early next year. Longer term, my best guess is the new normal for mortgage rates will be around 4.5% to 5%, with the base rate around 4%."
The Eighties
David Robinson, co-founder at Wildcat Law. said "back to the future or more specifically 1980; beware the spectre of stagflation. Interest rates had been forced higher by inflation, but he believed the looming storm on the horizon was the prospect of business failures as they struggled to obtain affordable working finance or passed on the higher input costs to already over-stretched consumers. This in turn will trigger a rise in unemployment; the main reason we have not seen this so far, has been that many vulnerable businesses ceased trading due to COVID.”
This left healthier more resilient businesses, which Robinson said "had so far weathered the storm, but he believes this ship could only take so much before it started to sink. Until inflation stabilises and falls, the Bank of England will continue to raise rates, but as we get closer to a general election, expect to see political pressure being brought to bear on all fronts."