Expect imminent increase in the cost of fixed rate mortgages

Today saw another sharp rise in gilt yields at the short end of the market, although there was a marginal fall in yields at the long end. The yield on 2 – 4 year gilts rose by around 0.15%, with the obvious knock on effect on swap rates, some of which rose even more. 2 year swaps were up by 0.22% to 2.48%, 3 year by 0.21% to 3.11% and 5 years by 0.14% to 3.76%. The 10 year rate was only 0.02% up at 4.24%. The recent lows for swap rates were on May 14, the day after the publication of the Bank of England’s Quarterly Inflation Report, when 2 year swaps closed at 1.98%, 3 years at 2.49%, 5 years at 3.14% and 10 years at 3.80%. Thus in just 3½ weeks 2, 3, 5 and 10 year swap rates have risen by a massive 0.50%, 0.62%, 0.62% and 0.44% respectively and this at a time when the Bank of England’s Quantitative Easing programme is meant to be driving down yields. This presents the Prime Minister, who is rapidly losing what little authority he has left, and the Bank of England with a major problem. Having pushed Bank Rate down to almost zero the strategy is to boost the economy by reducing the cost of longer term borrowing. This sharp upward movement in market rates demonstrates that the Government is impotent in this area and has lost control of interest rates except at the very short term end. This situation has some parallels with the US. The yield on the US benchmark 10 year Treasury Bond bottomed out on 15 January this year at 2.14% but closed a whopping 1.69% higher last week at 3.83%, after rising 0.37% on the week. As a consequence rates on a US 30 year fixed rate mortgage, the most common type of mortgage in the US, have risen by 0.45% in the last month alone to around 5.45%. Following such a sharp rise in swap rates here in the UK I expect several lenders to increase their rates for fixed rate mortgages over the next few days, but there is no reason to expect tracker rates to increase as 3 month Libor is still slowly edging lower and at 1.25% the margin of 0.75% over Bank Rate is the lowest it has been for several months. With most borrowers (around 80% of our clients) currently choosing a fixed rate mortgage, if interest rates continue to rise the current recovery in the housing market, which is based primarily on much improved affordability as a result of the combination of lower house prices and lower interest rates, is in danger of being snuffed out.