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Fix or float?

After the recent sharp rise in the cost of five-year fixed rates, the big question now facing most borrowers and their advisers is fix or float?

For some people, the choice is easy because they like the security offered by a fixed rate and make the choice on that basis. But for those making the judgement on the basis of which they expect to be cheaper, the key question is whether the City is getting ahead of the reality.

Many people overlook the monetary policy committee’s secondary objective, as clearly stated in last week’s quarterly inflation report, and there is currently a huge conflict between the two objectives that the Chancellor has set the MPC. This secondary requirement is to support the Government’s objective of maintaining high and stable growth and employment.

Bank of England governor Mervyn King made it clear that the MPC has made no decision on interest rates yet. He said: “It may be many quarters before we do anything. It will depend on the facts.” He was at pains to point out that he is not endorsing the market’s views and is not laying the grounds for a rate hike. He said those people who believe the bank has already decided to lift interest rates are “running ahead of themselves”.

In its report, the bank says it believes inflation will continue to increase further in the short term, with its central forecast being for it to peak at 4.4 per cent. However, King said the bank still believes that inflation will fall back next year as the impact of the latest VAT increase is stripped away and as recent “price shocks” from soaring commodity prices are unlikely to be repeated.

Market expectations predict a first increase as soon as May, with bank rate rising to 1.25 per cent by the end of the year.

Answering a question about whether rising energy prices and food prices really are temporary, as the bank has repeatedly insisted, King said: “In order for inflation not to fall back you would have to see increases in prices of the same magnitude next year.”

He pointed out energy prices have jumped by 15 per cent over the last quarter and food prices have rise by 20 per cent. He said “a reasonable view is that that is not likely” to be repeated a year from now.

King also talked about the fact that the growth outlook for the UK remains uncertain and there are downside risks. In fact, the bank has cut its growth forecasts, with King saying the growth in the closing months of 2010 was “weaker than we expected even taking account of the weather”.

With the differential between the best floating rates and the best comparable five-year fixes now around 2 per cent, bank rate will have to average at least 2.5 per cent over the next five years to make a five-year fix cheaper.

Ray Boulger is senior technical manager at John Charcol


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