Prospects for UK Mortgages 2007-2008

The Bank of England recently increased interest rates for the forth time in 9 months to 5.5%, thereby increasing the cost of mortgages. The prospects for future interest rates are mixed, although most commentators expect rises in the short term.

April inflation figures showed that inflation has fallen back within the governments inflation target of 1-3%; CPI inflation is now 2.8%. The older measure of inflation, RPI (which includes mortgage and housing costs), also fell to 4.5%.

Overall, evidence suggests that the Bank of England is still likely to rise interest rates further in 2007. This means that mortgage costs, for those on variable mortgages, will continue to rise. (e.g. £120,000 mortgage will see a £22 rise from even a quarter point rise in interest rate)

Reasons for increased interest rates include:

1. The Bank of England is keen to maintain a hawkish stance on inflation. It wishes to reduce inflation to 2% and not allow it to remain close to the upper level of 3%. Mervyn King, hinted at this stance in a recent announcement. [2]

2. There are still underlying inflationary pressures in the economy. An increasing number of suppliers are experiencing supply constraints.
Manufacturing Output is showing signs of renewed growth [1] Retailers are also saying they feel that they can get away with passing cost increases on to consumers. Something absent in recent years.

3. Retail Price inflation is higher than CPI. At 4.5% it is significantly higher than the old RPI target of 2.5%. Most pay deals are based on RPI, it is viewed as a more reliable measure of the actual cost of living.

However, despite these inflationary pressures. There are good reasons to believe that the cost of mortgage borrowing may start to fall by the end of 2007; by 2008 interest rates may be able to fall by even more.

1. Interest rates often have a delayed impact on spending and the economy. The 4 previous interest rates changes are now starting to have an effect, (due to high levels of personal debt) small rises in interest rates may have a significant impact on the economy.

2. House Price rises are still in double figures. However, many analysts are confident that rising interest rates will put an end to the long housing boom. Increasing unaffodability of Housing also increases chance of lower house price inflation. This may bad news for homeowners, but it will enable lower interest rates and lower mortgage payments.

3. Gas and Electricity prices expected to fall. Last year saw record rises in Gas prices, due to supply constraints. Now these supply constraints have been fixed it is likely gas prices could fall by as much as 20%.

4. Low global inflation. The benefits of globalisation are still in evidence. For example, the price of manufactured goods remains low. Inflation in the EU and US also, continues to be low.

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