Central banks believe that raising and lowering interest rates fine tunes the economy and controls inflation.
But the Bank of England’s latest quarter-percent base rate cut will probably leave both savers and borrowers worse off. Thursday saw the Bank shave another quarter-percent off interest rates, taking base rate to 5%.
Most big mortgage lenders immediately said they’d pass this on, but since they'd all effectively raised the rates they are charging borrowers in the previous month or two, this doesn’t leave most borrowers any better off than they were a few weeks ago.
Riskier loans get pricier
Last autumn, after Northern Rock showed how lenders had driven a coach and horses through ‘prudent lending’, the regulators went into overkill mode and fired off warning letters to banks. The banks were sternly warned that they must assess the risk of their mortgage lending on a sensible and prudent basis.
Only an idiot banker would have ignored the unspoken message: increase interest rates on riskier loans. So they have, and in spades. While there are still 5.5% offers out there, fewer people qualify for them, while arrangement fees of nearly £1,000 are now the price tag on the best deals, available only to those needing to borrow less than 80% of the value of their property. Most standard variable rates will be 6.5% or more after the latest cut.
Nor is there an end in sight. The banks know there is more demand out there for mortgages than they can supply without ‘securitising’ loans in the same way that Northern Rock did. But right now, they couldn’t securitise a mortgage on Buckingham Palace, because the buyers of securitised loans are on strike. So the best way of choking off demand for mortgages is to raise prices, which is what almost all banks have been doing- HSBC being an exception.
Lending margins keep rising
Last summer, banks were content to make an ‘interest margin’ – the difference between the rates at which they borrow and lend money - of as little as half of one percent on mortgages. Today, the lending margin is over 1% and is heading higher, as lenders simply can’t meet demand.
So mortgages get more expensive despite cuts in base rate. The only thing that will stop this trend is not further base rate cuts but the reopening of the securitisation market. And the only way the Bank can do that is by agreeing, in a major policy shift that it hasn’t yet accepted as necessary, to accept mortgages from banks as collateral for loans.
The shortage of mortgages is already affecting the housing market, with the Halifax index down 2.5% in March, showing its biggest monthly fall since 1992. First time buyers are virtually frozen out of the market at present, which is not helping demand. The next few months could be quite grim in the housing market, but I expect more sellers to withdraw their homes from the market and sit tight.
The crunch and the recovery
This has the makings of a mini 1990s-style housing crunch, with these key differences:
• without a big rise in unemployment there can’t be a full-blown housing slump
• rents are stable or rising, so once loans are available, investors will return to the BTL market
• actual mortgage interest rates are likely to peak in the next few months
I started getting gloomy about housing over a year ago, but now that the papers are starting to shriek about doom and gloom, I’m starting to feel a bit more positive. Forget the hopes and dreams stuff: what a house is really worth depends on what someone will pay to rent it.
If you can get a return of 6-8% on your money from owning and letting a house, it makes sense to buy it. Those sorts of yields are now starting to be available, and at the same time interest rates are starting to fall. So when money becomes available, people will buy.
Of course, the housing market is somewhat like a supertanker and once momentum builds up it takes time to turn. So I reckon it will be autumn this year or spring next year before the statistics show the beginnings of a recovery. But if you’re a bargain-hunter, you should be scouring the property auction rooms long before that.
Savers will suffer if mortgages get easier
As for savers, the only thing keeping deposit rates high is the banks’ need to attract money to fund their lending. But instant access account rates are likely to drop in coming weeks and I don’t expect there will be many 6% offers left on the table. The best rates are likely to be on cash ISAs, where banks are hoping to persuade us to switch many of our old cash ISAs into one new account by offering enticing rates.
If the Bank of England does success in unfreezing the mortgage market, that will mean the interbank rate - the rate at which banks lend to each other- will fall from its current 5.9% to where it normally is, in line with base rate.
It is the interbank rate that determines savings account rates, so if the Bank does succeed in getting mortgage rates to fall, there’s likely to be an even bigger drop in savings rates. Grab the best fixed rates now.
