When will interest rates rise? This is a question everyone would like to be able to answer, we would all fix our mortgages and just the moment before they increase – perfect!
If we do not have a crystal ball then we need to be looking to the wider economic situation for signs that rises are on the way.
One of these such signs I believe is the announcement by the Bank of England that it is halting of the Government’s Funding for Lending Scheme (FLS) for household lending from January 2014.
Do not confuse this with Help to Buy, that is something completely different, see my earlier blog here.
The FLS was introduced to incentivise banks and building societies to boost their lending to the UK real economy. By providing funding to banks and building societies for an extended period, with both the price and quantity of funding provided linked to their lending performance not a rated price.
To understand the effect FLS has had on our interest rates and in keeping them low, we need to understand how interest rates are set in normal circumstances.
Loan rates for all types of loans, including Mortgages, Car Loans, Loans for Businesses are priced off the Interest Rate returns placed on Government Issued Debt in the form of UK Gilts. Banks compete for the funding in the open market and then lend it out to us in th eform of mortgages and loans at a higher rates (spread income) than they are paying in order to produce a positive return for themselves.
Between 1998 and 2008 the average difference between the Gilt price and the typical Variable Mortgage Rate was +1.97%. That makes sense, that is the average difference between what the banks pay for their money and the price they lend it to us at.
Since the launch of the FLS there has been a very interesting and worrying change to this difference in these figures.
Typical 2 year Fixed Rate mortgage price has dropped from 3.75% down to 2.5%. A typical variable rate mortgage at the moment is 1.9%.
While the UK 10 Year Gilt Yield has moved up from 1.4% to 2.9%. That is a difference of minus 1.0 %.
So there is surely only one way our household interest rates can go as of January. So if you are looking to buy a property, get your DIP’s done now, forget your Christmas shopping go mortgage shopping now. It will be very interesting how this change so early in 2014 will affect us all and how it will impact the economy in the New Year.