UK mortgage rates are under renewed pressure as financial markets price in a series of potential interest rate rises from the Bank of England, a Knight Frank analysis shows.
This comes despite limited evidence of a new rise in inflation in the local economy, according to Tom Bell, head of UK housing research at Knight Frank.
The five-year swap rate rose above 4.7% on Tuesday, its highest level since September 2023, as worsening security concerns around the Strait of Hormuz sparked fears of higher energy prices.
Swap rates are closely watched by mortgage lenders because they reflect market expectations of future interest rates, Bell said. Movements in swap markets can affect the cost of fixed-rate mortgages even before the Bank of England changes the interest rate.
The recent rise has added to uncertainty about the outlook for borrowers, with markets pricing in several potential interest rate hikes through 2027.
However, the assumptions behind these forecasts are increasingly related to the uncertain course of the conflict in the Middle East rather than clear signs of accelerating inflation in the UK.
Recent UK economic data has provided little evidence of significant additional inflationary pressures.
Services prices and core inflation were unchanged on Wednesday, following the release of weaker-than-expected labor market data the previous day.
The discrepancy between relatively weak local economic indicators and high market expectations made the outlook for fixed-rate mortgages particularly difficult to predict.
Fixed rate products account for approximately 90% of UK mortgage lending, meaning changes in swap rates can have a significant impact on borrowers seeking to purchase a property or refinance an existing loan.
High borrowing costs have already dampened housing market activity and price growth this year. Additional increases could place additional pressures on transactions and affordability.
Mortgage lenders have been raising fixed interest rates in recent days, according to Simon Gammon, managing partner at Knight Frank Finance.
The move has prompted some borrowers to consider tracker mortgages, which typically charge a fixed margin above the bank rate.
With some tracker mortgages currently priced at around 4%, compared to fixed-rate deals at around 4.75% or higher, several interest rate increases from the Bank of England would be needed to close the current gap, Gammon said.
This calculation is particularly important given the uncertainty surrounding the number of interest rate increases that markets expect to eventually occur.
Market analyst Michael Brown said expectations of a five-fold increase in interest rates by the Bank of England by the end of 2027 seemed difficult to justify based on current conditions.
“A rate hike in November is sensible, if only to prevent the Bank of England from being seen as being behind the curve compared to its peers,” Brown said.
He added that energy prices and the potential for so-called second-round inflation effects — where higher energy costs feed into wages and other prices — would be important factors for policymakers.
The Federal Reserve and European Central Bank raised interest rates this month, while the Bank of England kept interest rates at 3.75% on Thursday as concerns about economic growth weighed on inflation risks.
Market expectations may also reflect caution following the initial economic impact of the conflict in the Middle East in March, Brown said. Traders who underestimated the previous rise in inflation risks may now be calculating a potentially larger shock.
This creates a rebound effect for mortgage borrowers: fears of another inflationary episode could push market prices higher even before there is evidence that the expected inflation has materialized.
The result is an unusually uncertain outlook for mortgage costs.
If tensions in the Middle East ease and energy prices decline, swap rates may decline. But a sustained rise in oil and gas prices could increase inflationary pressures and make it more difficult for the Bank of England to cut interest rates.
Other global factors also affect borrowing costs, meaning any decline in UK mortgage interest rates may not fully reflect recent increases.
For borrowers, the immediate direction of mortgage pricing could depend as much on developments in global energy markets and the Strait of Hormuz as on the next set of UK inflation and employment figures.
The rise in borrowing costs also has implications for the wider economy and government finances, with Chancellor John Healey facing additional pressure ahead of next month’s Budget.
