What goes up must come down, but for mortgage rates the drop will be notably more gradual than the sharp increase triggered by the Middle East conflict.
Reasons include the long-term inflationary impact of the war and weaker demand for UK government debt, said Helen Thomas, CEO of political and economic consultancy Blonde Money, on the latest episode of Housing Unpacked.
Even if the current two-week ceasefire deal holds and transaction volumes recover as the spring market gets underway, mortgage rates won’t snap back to where they were in mid-February, which will keep prices in check.
Higher bond yields, which tend to mean higher fixed-rate mortgages, reflect the fact investors are pricing in more risk due to the government’s tight financial headroom, its inability to control spending and the high volume of debt it has issued at a time when global demand is falling. The Middle East conflict has magnified these vulnerabilities.
RISK PREMIUM
“Political decisions have been taken that mean the UK gilt market is very volatile,” said Thomas. “When we see rates rise and bonds sell off, you see a bigger move in the UK, which shows you there is a higher risk premium than other G7 countries.”
The political decisions include reversing a plan to cut welfare spending last year and lifting the two-child benefit cap on Universal Credit. Meanwhile, bond investors also see the high overall UK tax burden as a risk.
“Everybody borrowed a lot of money after Covid so there’s a huge amount of debt to be re-financed in the world,” said Thomas, underlining how investors everywhere are demanding a higher yield as the supply of government bonds rises.
“The supply of corporate bonds has also grown, particularly for industries like AI which require massive capital investments.”
PROLONGED INFLATION
A prolonged period of inflation due to the Middle East conflict will also keep upwards pressure on mortgage costs, said Thomas.
Rising oil and natural gas prices have pushed inflation expectations higher since the conflict began, which has already had an impact on rates. The best 5-year fixed-rate deals currently exceed 4.8%, which is more than a percentage point higher than before military action started.
Combined with weaker overall sentiment, it has curbed activity in the housing market so far this spring.
The time it will take for commodity backlogs to clear and transport networks to normalise means that upwards pressure on inflation will persist for many months, said Thomas, citing the example of a single ship that got stuck in the Suez Canal is 2021.
“The whole thing took about two months to fully get back to normal. That was one ship for six days. There are normally 150 ships a day transiting through the Strait of Hormuz but apparently over the last month we’ve had 150 in total. The downstream implications are huge.”
Despite the logic of higher rates, the Bank of England needs to consider the potential damage of increasing borrowing costs given the weak state of the labour market and low levels of economic growth, as discussed on a recent episode of Housing Unpacked.
BALANCING ACT
Bank of England Governor Andrew Bailey acknowledged the difficult balancing act last week after the Bank’s latest rate decision and accompanying comments were more hawkish than expected.
“(The market)’s still pricing us to raise rates. I would still say that is a judgment markets have to make but I think they’re getting ahead of themselves,” he said.
Markets were fully pricing in one rate hike in 2026 after Wednesday’s ceasefire deal was announced, which compares to two at the start of this week.
“Assuming the ceasefire does lead to a durable peace deal, and the normalisation of energy flows, then there’s next-to-no reason that the Bank would even think about hiking rates, and actually a path emerges for them to deliver one or two cuts by year-end if the labour market remains soft,” said Pepperstone analyst Michael Brown.
That said, the Bank of England was stung by accusations that they were slow to act on inflation after the invasion of Ukraine in 2022, said Helen.
“If they lose that anchor (managing inflation expectations) as they almost did frankly a few years ago then their credibility is gone. That’s why they have to lean on that slightly more hawkish side of things.”
Helen Thomas also discusses the UK political landscape and whether the conflict will buy Keir Starmer more time before he faces a leadership challenge. He is widely expected to come under pressure after the local elections on 7 May.
And does Thomas think a Liz Truss-style bond market shock or a challenge from Angela Rayner will end Starmer’s premiership first? Listen to the podcast to find out.
