UK mortgage rates could start to reduce within weeks as inflation drops

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Cheaper mortgages could be available within weeks on the back of better than expected inflation figures that suggest interest rates are close to peaking.

In the first piece of good economic news for the government in months, the Office for National Statistics said that consumer price inflation had fallen from 8.7 per cent in May to 7.9 per cent in the year to June. There was also a drop in the rate of core inflation, which strips out food and energy prices, from 7.1 per cent to 6.9 per cent.

The data has boosted hopes that the Bank of England will not have to increase the base rate, now at 5 per cent, much further, which could bring down borrowing costs sooner than expected.

Rishi Sunak, the prime minister, said the figures showed that the government had the right approach and insisted that he was going to “stick to the course”. He said: “I know things are difficult for people right now but today’s figures should give people some comfort that the plan is working.”

Jeremy Hunt, the chancellor, said the government was not complacent but suggested that he expected to meet Sunak’s target of halving inflation by the end of the year.

Mortgage rates have risen rapidly since May after consecutive annual inflation figures were worse than expected. From May 1 to last Friday the average two-year fix rose from 5.26 per cent to a 15-year high of 6.78 per cent.

The hope is that now inflation is lower than expected, the Bank will not have to raise interest rates as much as feared, which will in turn lead to lower mortgage rates.

David Morris, chief commercial officer at Yorkshire Building Society, said: “There’s a few weeks’ lag between the underlying funding rate and what mortgage rates do, but I think you will see that flow into pricing over the next two to three weeks, as it’s in lenders’ interests to offer cheaper rates.”

The pace of rate rises has slowed this week, with average mortgage rates unchanged between Friday and Tuesday, according to the financial data analyst Moneyfacts. The average two-year fixed rate rose to 6.81 per cent on Wednesday and banks including NatWest and Virgin Money said they would increase rates.

However, Chris Sykes, of the mortgage broker Private Finance, said: “Wednesday’s news will give lenders more breathing room to maintain fixed rates and even look at rate reductions sooner than expected if this direction of travel continues.”

The EY Item Club, the economic forecaster, now expects a 0.25 percentage point rise in the Bank rate next month with a potential final increase in September, before the cycle of rate rises that started in December 2021 comes to a halt.

Martin Beck, its chief economic adviser, said: “The direction of travel is now looking more favourable, following a period when UK inflation appeared to be very sticky.”

Financial markets reacted positively to the inflation news, and there was a sharp drop in swap rates — the expectations of the future Bank rate that are used to price fixed-rate mortgages. The two-year swap rate dropped from 5.93 per cent on Monday to 5.46 per cent on Wednesday.

It is these swap rates, coupled with banks being inundated by homeowners trying to secure new mortgage deals before they become even more expensive, that has driven the sharp rise in borrowing rates since May.

Morris said: “I think what you will see is lenders looking to take this opportunity to offer some really good rates. I’d certainly expect to see cheaper rates and I think competition in the market will be a big reason for that.”

The banking trade body UK Finance said more homeowners were betting mortgage rates were close to their peak and taking out more expensive two-year deals in the hope rates will have fallen by the time they remortgage.

Two-year fixed-rate deals were the only type to increase in popularity between April and May, it said, accounting for 34 per cent of new mortgages, up from 30 per cent. The percentage of loans taken out on five-year fixed-rate deals fell for the sixth consecutive month to 48 per cent, down from 66 per cent in November.