Among the doom and gloom is some good news. The fall in the oil price from over $140 to under $100 per barrel means inflation will fall sharply next year, and interest rate cuts will follow.
The big rise in inflation over the past year has been due to fuel and food prices. But both have registered such steep rises that only if they kept on rising at the same rate could the annual rate of inflation stay at the same level. Even if all oil prices did was stay stable, the rate of inflation would fall. As it is, lower oil and energy prices will feed through the whole production and distribution chain, bringing down lots of prices and sending RPI inflation down from a possible high of 5% in the next couple of months to about 3.5% by the middle of 2009, with CPI inflation likely to be under 3% at that stage.
Food prices may not fall in the way oil has, but they look likely to stabilize rather than keep on rising – so two of the biggest contributors to rising inflation over the last year will now be working to bring the headline rate of inflation down.
Rate cuts on the way
That, and the growing evidence of a weakening economy, will provide the Bank of England with the reasons it needs to cut interest rates. Economists expect Base Rate to fall from its current 5% to 4% by the end of 2009.
As usual, the economists are being conservative and only changing their forecasts slowly in response to what is happening, and in fact I think it’s likely that base rate will be down to 4% by summer next year.
That should provide some cheer for borrowers, especially people with variable rate mortgages. A 1% cut in rates is a saving of £60 per month (a 9% cut in repayments) on a £100,000 mortgage.
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Trackers are the best option now
The likely downtrend in interest rates over the next year or two means that homeowners should, in my view, now opt for variable interest loans rather than fixed rates. But as we have seen recently, mortgage lenders do not have to pass on all of a cut in interest rates on loans at their Standard Variable Rates.
That’s why I think a tracker mortgage linked to the Bank of England Base Rate itself is a better option. It means you are sure to benefit from any reduction in interest rates.
Several lenders have offers of lifetime trackers at around 0.7% above base rate. Or you could get a lower rate for a short period of a year or two, but then pay a higher rate. Fixed rate loan rates too have dropped, with offers around 5.4% for two or three years. But if interest rates do fall as sharply as I expect, these fixed rates could look expensive in a year’s time.
Barclays/Woolwich and Lloyds TSB/C&G made further small mortgage rate cuts last week, confirming my view that the mortgage market is now once again quite competitive for loans at under 80% LTV.
Grab fixed rate bond offers
The increasing likelihood of interest rate cuts means that savers can expect sharp cuts in the high rates currently on offer. Fixed rate bonds paying 7% are getting rare but could soon vanish completely.
ICICI, Firstsave and Anglo-Irish Bank are among those with 7%-plus fixed rate offers on the table. Yorkshire Bank’s 3-year term deposit at 7.22% looks a very tasty offer that could be withdrawn any time.
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