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When will bank rate break out?

The decision of the Bank of England’s monetary policy committee to leave bank rate at 0.5 per cent brought sighs of relief from cash-strapped borrowers but anguish elsewhere.

Existing mortgage borrowers are enjoying an Indian summer of easy repayments, as the bank’s rate not only remains fixed at its lowest rate ever but also remains unchanged for the longest period since the Second World War, with 19 months having passed since its last change.

But savers who depend on interest payments for their income, and mortgage lenders such as Nationwide Building Society, which is contractually bound to offer to many of its long-standing borrowers a standard variable mortgage rate tied to the abnormally low BoE figure, cannot hide their frustration that the bank’s official rate has stood still for another month.

The fact that the rate has been the same for a period unprecedented in many people’s lifetimes does not mean it must soon be on the move.

In October 1939, the bank rate fell to 2 per cent and remained there for almost continually for more than 12 years. There was a short spike when on August 4, 1939, just before war was declared, it doubled to 4 per cent, but just two months later, on October 26, 1939, the rate went back down to 2 per cent, where it remained until November 8, 1951.

John Charcol senior technical manager Ray Boulger says: “It seems unlikely that this record of no change in bank rate for just over 12 years will be beaten this time round but it is perhaps worth noting that during the last period of severe austerity, bank rate remained unchanged for over seven years, from June 1932 to August 1939.”

Boulger’s view is that bank rate will remain low for a long time and when it does start to rise, the increases will be slow.

Yet not everyone agrees with this view and it could be inflation that is the determining factor.

At 3.1 per cent, consumer price index inflation remains stubbornly above the Government’s 2 per cent target rate. Retail price inflation is higher still at 4.6 per cent.

In the normal course of events, if inflation remains above target, pressure will build for rates to rise to knock it on the head. At present, economists’ opinion is divided over whether the threat we face is inflation or its sinister cousin deflation – the advent of which could leave us in economic limbo like Japan, which suffered a lost decade of stagnation.

When it comes to lending, swap rates have been falling steadily over the past two years, from 5.26 per cent in October 2008, when the Bank of England first started to cut interest rates aggressively, to around 3.3 per cent at the start of the year and just 1.29 per cent now.

Meanwhile, over the past month, the typical cost of a two-year fixed-rate mortgage fell by a further 0.08 per cent, to 4.4 per cent, to reach its lowest level since records began in 1988, according to figures from Moneyfacts.

Three and five-year fixedrate deals similarly fell to 5.04 per cent and 5.36 per cent respectively, both also the lowest ever recorded, as competition continued to drive rates down and lenders narrowed their margins.

Mortgage borrowers should not, however, become complacent. The bank’s monetary policy committee has been divided for some time about where we are headed. This month’s meeting of the MPC shied away from more quantitative easing but the minutes of the MPC meeting the previous month showed that, for the fourth month running, Andrew Sentance had voted for an interest rate rise to combat the inflation that we are already experiencing.

His views are backed by Sir John Gieve, former deputy governor of the Bank of England, who also believes that interest rates will have to rise.

Sentance was comprehensively outvoted by his MPC colleagues but the fact remains that serious inflation is a possibility as QE works through the system.

Commodity and utilities prices continue their upward trajectory and increased VAT from next January is expected to push up retail prices. In such circumstances, the bank would have to act fast and punitively.

The dire warnings about the potential for rising rates suit brokers and lenders just fine.

Brokers always want to do business and those lenders with swathes of borrowers on ultra-cheap SVRs and trackers priced before the credit crunch struck would love to lock them into more profitable deals.

Borrowers seem to have other ideas and are either reluctant or unable to switch.

The latest figures on remortgaging from the Council of Mortgage Lenders show that remortgaging accounted for just 25 per cent of loans in August, the lowest proportion in over 10 years.

Yet more than a quarter of respondents polled recently by the comparison website moneysupermarket.com said they would be worried about a base-rate increase affecting their mortgage repayments. Moneysupermarket has calculated that, if bank rate returned to pre-crunch levels of around 5 per cent, someone with a £150,000 interest-only mortgage currently on a 2.5 per cent SVR would, if their SVR rate followed the bank rate upward by a similar percentage to 7 per cent, see their monthly repayments jump by as much as £563.

Moneysupermarket.com head of banking Kevin Mountford says: “Rates can only go one way. Families should think about their monthly outgoings now to prepare for the inevitable increase on their mortgage repayments. Anyone sitting on their lenders’ SVR should consider fixing now before rates begin to rise.”

Unfortunately, looking at bank rate in isolation may not be all that helpful, since the movements in the bulk of mortgage rates, aside from trackers, are dictated by swap rates rather than bank rate.

As one expert put it: “If you look at the history of the swap rates, which largely dictate the cost of mortgages, the likelihood of a borrower ever having to pay, say, 7 per cent interest is extremely slim.”

Slim, perhaps but not impossible, as anyone who lived through the early 1980s will testify.

So, although anyone shifting from an ultra-low SVR or tracker could miss out if rates remain low, locking into a fixed rate now might not be such a bad idea – and for reasons other than base rate movements.

One of these is sliding property prices.

First Action Finance head of communications Jonathan Cornell says: “A significant fall in house prices will severely limit the ability to remortgage, as borrowers without large amounts of equity may not be able to secure the rate they are trying to remortgage on to, as lenders’ cheapest rates are reserved for those borrowers with large amounts of equity. News from the Halifax that house prices dropped by 3.6 per cent last month would mean that some borrowers’ equity has reduced substantially.

“Nervous homeowners who are now hovering just above lenders’ key loan to value for their cheapest rates, like 60 per cent and 70 per cent LTV, may choose to remortgage now rather than later if they feel that house prices will continue to drop.

“The other factor is the Government spending review. Public sector workers who are nervous about their jobs may choose to remortgage now while they are still employed rather than wait and be unable to remortgage while they are unemployed.”

Other factors that could push people into remortgaging sooner rather than later are new rules coming out of the FSA putting further restrictions on lending, including a block on interest-only loans and cautious income multiples. This could dovetail with banks embarking on a new round of tightening their lending criteria if the economic outlook deteriorates.

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