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Mortgage rates reach new lows - and the outlook remains positive


Published: 5 February 2015 | Author: Bernard Clarke

Last November, the average new tracker mortgage rate fell to 1.96%, according to our regulated mortgage survey – the first time that it has ever dipped below 2%. For fixed-rate borrowers, it’s the same picture, with some lenders offering the lowest long-term rates the market has ever seen. 

So, what is driving this trend? And how might it be affected by future economic developments?

Last week, the UK 10-year gilt yield fell to a fraction over 1.4%, a level not seen since the last eurozone crisis. But capital markets are now very different from those dark days. Then, the UK was seen as a safe haven – now the view is that European regulatory measures are strong enough to cope with potential threats.

Chart One: Average mortgage interest rate, by type of rate

05.02.2015 Chart One Average mortgage interest rate, by type of rate

Source: CML regulated mortgage survey

The market conditions that have produced such low gilt yields have great significance for UK lenders, who obtain funding from a variety of sources. 

Smaller lenders, who cannot access capital markets, tend to rely on retail funding. Despite the low rates on offer to savers, lenders are continuing to see large inflows of retail deposits. Last year’s increase in the ISA limit to £15,000 has boosted the savings market and, while there has been an increase in flows into stocks and shares ISAs, the vast majority of funds – more than £40 billion in the last year – went into cash ISAs. 

It is this flow of low-cost funding that is helping lenders keep mortgage rates at historic lows. While there has been some additional competition in the market from NS&I’s pensioner bonds, the outlook for retail funding looks set to remain strong, as consumers continue the recent trend of a return to a saving culture.

Meanwhile, larger lenders are benefitting from favourable conditions in wholesale funding markets. 

Institutional investors, in the form of pension funds and insurance companies, continue to look positively on the UK financial sector. That translates into considerable demand for UK financial assets (both bonds and equities), and lenders have taken advantage of these conditions to raise funding by issuing in a variety of markets, including covered bonds and securitisation. 

Not only have lenders been able to raise funding at an exceptionally low cost but also, by using a variety of funding sources, they have been able to diversify their options to keep costs down across all funding markets. And these favourable conditions have had their effect in helping to deliver lower mortgage rates.

The economy and interest rates

Once again, there are concerns about the eurozone – and these have intensified in recent weeks.  Questions persist about the possibility of disruption from Greece. And there has also been speculation about whether deflation could become a persistent feature of European economies. On the later question, we have seen a regulatory response, with the introduction of a form of quantitative easing in Europe, intended to mitigate the affects of deflation. 

Proposed reforms of banking supervision

Just before Christmas, the Basel committee on banking supervision published a consultation document on proposed revisions protecting the international financial system and financial institutions from credit risk. The consultation period ends on 27 March.

The proposals could require lenders, in the UK and elsewhere, to hold more capital against risks associated with mortgage lending as part of measures targeting wider perceived credit risk. The proposals could have implications for the mortgage market in the UK and elsewhere, depending on when and how they may eventually be implemented. But the outcome is far from certain at this stage.

In response to recent press coverage of the Basel proposals, we issued the following statement:

"On behalf of UK lenders, we will be submitting a detailed response to the proposals, which could affect the cost and availability of mortgages, as well as funding for homes in the private and social rented sectors. The proposals could make borrowing more expensive generally, and less readily available for those who represent a higher risk.

"The current consultation is on proposals to strengthen the standardised approach to assessing capital requirements for lenders, used by smaller firms. But we are also expecting proposals at a later stage that could modify the internal ratings-based approach to assessing capital. This is used by larger firms and could affect their costs. We will be responding to these proposals when they are published.

"The re-assuring news for lenders and borrowers is that they are highly unlikely to see any immediate effects, as the proposals will take some time to implement. They may also be modified in response to the consultation process or when they are implemented by the authorities in the UK and Europe, who may choose to mitigate some of the effects."

What next?

We will be setting out our views on the proposals in a future article in CML News & Views around the time we submit our response in March.

In the UK, prospects for economic growth, expectations for inflation and the ready availability of funding – both from wholesale and retail markets – are continuing to have a significant impact on the level of domestic interest rates.

Macro-economic factors will continue to have implications for interest rates – and the reassuring news for borrowers is that the outlook for the UK economy is relatively benign. Inflation remains subdued and the economy is continuing to grow. So, low interest rates and low mortgage rates are underpinned by a positive macro-economic backdrop. 

Obviously, there may be some bumps in the road, and market volatility could affect funding rates. There remain some large geo-political risks both in Europe and further afield. However, if these bumps can be successfully negotiated, the outlook will be for low mortgage rates to continue.