Does inflation falling mean mortgage rates will go down?

Inflation fell to 4.6 per cent in October, a big drop on the 6.7 per cent recorded in September.

This surpassed the expectations of many analysts, who had predicted inflation to fall to either 4.7 per cent or 4.8 per cent.

It also represents a huge improvement on this time last year when inflation peaked at 11.1 per cent, and means the Government’s target of halving inflation to 5 per cent by the end of the year has already been hit.

One of the biggest impacts of high inflation has been much higher mortgage rates, so many homeowners will be asking whether they will now get some respite. 

With inflation forecast to continue falling over the coming months, this will remove the core reason for the base rate rising in the first place.

Analysts at Morgan Stanley have already forecast that interest rates will be cut as soon as May next year and fall to 4.25 per cent by the end of 2024.

Meanwhile, Capital Economics predicts that interest rates will now be held at 5.25 per cent before they are cut during the second half of next year. It predicts that the base rate will fall to 3 per cent by late 2025.

What does falling inflation mean for mortgages?

Mortgage lenders change their fixed mortgage rates on the back of expected funding costs, which are ultimately tied into the market’s predictions about how high the base rate will ultimately go, and this is in turn closely linked to the outlook for inflation. 

The more inflation falls, the more confident markets will become that interest rates will be cut in the near future.  

After today’s inflation figures, many are predicting that the Bank of England will hold the base rate at 5.25 per cent before cutting rates next year.

Market expectations are reflected in swap rates. Put simply, swap rates show what financial institutions think the future holds concerning interest rates.

Swap rates have fallen in response to the inflation data, with five-year swaps falling from 4.27 per cent to 4.12 and two-year swaps falling from 4.78 per cent to 4.66 per cent since Monday. 

Only as recently as July, five-year swaps were above 5 per cent. Similarly, two-year swaps were coming in around 6 per cent.

And mortgage lenders have already been reducing their rates on the back of more positive noises about inflation and the base rate.  

Chris Sykes, a mortgage consultant at Private Finance, says this decline alongside today’s inflation figures may prompt further reductions.

He says: ‘Today’s inflation data may stimulate increased competitiveness among lenders, leading to further rate cuts, especially in the two-year fixed-rate residential market.

‘HSBC, swiftly followed by Halifax, announced rate cuts on the day preceding the release of the inflation figures, showcasing their confidence to act competitively in the current market and their expectations regarding future cost of funds.

‘The implications of this inflation data will contribute to shaping expectations for the direction of the base rate in the coming year, and could influence expectations of an earlier base rate decline in 2024.

‘Such a shift would directly impact tracker rates and might contribute to their increased popularity as individuals seek to “ride the rate wave” down and benefit from their flexibility.’

Matt Smith, mortgage expert at Rightmove, also expects today’s inflation figures will further encourage lenders to slash mortgage rates.

He adds: ‘Lenders have accelerated mortgage rate reductions over the last week and this morning’s positive inflation news will only fuel confidence amongst lenders further that they can continue to drop rates over the final weeks of this year, barring any last minute surprises.’

> What would a mortgage cost you? Check based on your home value and loan size 

What does this mean for the housing market?

The housing market has suffered from a dearth of activity rather than a house price crash thus far.

House prices fell annually in September for the first time since April 2012, according to Land Registry figures, but the 0.1 per cent fall still means that house prices are on average, £60,000 or 26 per cent higher than they were before the first coronavirus lockdown in 2020.

But those official figures lag other reports that shopw much larger falls, for example, Nationwide’s house price index is down 3.3 per cent annually and almost 6 per cent from its August 2022 peak.

Many home sellers are also finding that they need to take much more than that off the price of their property compared to the market peak to get it sold. 

Higher mortgage rates have hit transaction levels hard. According to HMRC figures, total house sales and purchases have fallen 17 per cent in the 12 months to September.

Housing market commentators believe that with inflation lower than expected in October, this will spell good news for the housing market.

Anthony Codling, head of European housing and building materials research at RBC Capital Markets says: ‘As inflation falls, it is likely that mortgage rates will follow suit.

‘Falling mortgage rates mean more people will be able to buy a home and activity in the housing market is likely to rise.

‘We expect the share prices of the UK housebuilders to react positively to the better-than-expected CPI numbers.’

Rightmove’s Matt Smith believes that lenders may relax their affordability rules, which alongside falling rates will help boost buyers’ budgets.

He adds: ‘With the markets anticipating that rates will fall back next year, coupled with recent positive wage data, lenders could begin to review their affordability criteria.

‘It has been a challenging year, with higher rates and the squeeze on affordability meaning that some movers have had to reassess their budgets and look at options such as extending mortgage terms or searching for cheaper properties.

‘An easing of affordability criteria would be positive news for many movers looking to take out a mortgage and is a trend to watch heading into 2024.’

When will mortgage rates dip below 4 per cent? 

Nicholas Mendes, mortgage technical manager at broker John Charcol, warns that while mortgage rates look set to fall further, they are unlikely to dip below 4 per cent until later next year.

Mednes says: ‘I’ve seen a few brokers saying we’ll get sub 4 per cent deals on the back of today’s inflation news, but I would just give a word of warning on that.

‘While to a certain extent we will see terms like “price war” being mentioned, lenders have a small window before they start to factor in seasonal changes.

‘I expect we will see rate changes for the next 3 to 4 weeks before lenders postpone for the new year.

‘Lenders will be walking a tightrope between trying to make up for lost time and win as much business as possible, but equally being aware of the impact on service levels.

‘The last two weeks are notorious for solicitors, surveyors and lenders with staff members breaking up for the Christmas period.

‘Lenders will be trying to avoid an overhang of service levels impacting the new year start.

‘We will continue to see sharp reductions before a slow down when lenders and mortgage holders tend to put off making any decision over the Xmas period.’

Mendes believes that next year could see many more first-time and movers push on with their home moving plans.

‘Property prices are expected to continue to fall over 2024 before picking up in 2025,’ adds Mendes. ‘The main driver is affordability, due to the impact higher rates have on borrowing and affordability.

‘We are expecting to see sub 4 per cent deals arrive in the second half of next year, which is probably going to be a good time to secure an affordable deal.

‘The second half of 2024 will be a good time to buy if you’re a home mover or first time buyer, before the market picks up and the competition increases as confidence grows.

‘This confidence and competition means this will be the driver for turnaround in property prices in 2025.’