Bank of England bank rate to peak at 1.25% to reduce mortgage repayments, says NatWest

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Pressure on homeowners from rising interest rates will become apparent by the second half of 2023, according to NatWest Markets, an expectation that will prompt the Bank of England to rein in rate hikes.

The UK lender says homeowners are currently largely protected against short-term Bank of England interest rate hikes as fixed-rate mortgages now make up the vast majority of the market, but most with tenors. life of 1 to 3 years, this protection will inevitably fade.

The Bank of England stated in a recent article that “the housing market is closely linked to consumer spending. When house prices rise, homeowners get richer and feel more confident.”

Any prospect of a reversal in house price growth in 2023 with rising mortgage rates could therefore contribute to an anti-inflationary slowdown in economic growth.


Image above courtesy of Pantheon Macroeconomics.


The Bank of England will therefore refrain from pushing interest rates as high as current money market prices suggest, for fear of squeezing the economy.

Market prices are currently pricing in a third rate hike coming in March and a Bank Rate of 1.75% by the end of the year, with further hikes expected in 2023.

But NatWest Market’s calculations suggest that this type of pricing would put the Bank Rate well above the level where the Bank of England will set the so-called terminal rate of this bullish cycle.

“The strongest monetary policy transmission channel in the UK is through the mortgage market given its size and sensitivity to changes in the bank rate,” says Ross Walker, UK Chief Economist at NatWest Markets.

“Part of the rationale for setting rates significantly higher than those signaled by BoE policymakers may rest on the idea that the high proportion of fixed-rate mortgages (~80% of stock) has removed a large part of the power of monetary policy,” he adds. .

But Walker argues that this assessment is flawed.

“One way to gauge how much the Bank Rate will need to rise is to model its impact on the cost of servicing household debt,” Walker says.


Mortgage rates to hit UK house price growth

Image above courtesy of Pantheon Macroeconomics.


Economists predicted a delayed pass-through of the Bank Rate hike to mortgage rates, with NatWest estimating that raising the Bank Rate to around 1.25% by August 2022 would be enough to drive up mortgage servicing costs. household (mortgage) debt to longer-term averages by the second half of 2023.

“We therefore view these discount rate levels as an approximation of a ‘neutral’ policy rate,” Walker said.

The neutral rate is the rate at which monetary policy is neither stimulative (as it is currently) nor restrictive.

It therefore presents a theoretical interest rate target for central banks trying to recalibrate policies after a period of stimulus.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, says rising mortgage rates will eventually limit house price growth, which will have far-reaching economic impacts.

“Households are protected against rising short-term rates,” says Tombs, “higher mortgage rates, however, will slow house price growth.”

The data shows that mortgage debt now accounts for around 90% of all UK household debt, which Walker says is considerable.

The FCA says the UK’s mortgage stock stood at £1.6 trillion at the end of the third quarter of 2021 and NatWest estimates this equals around 100% of after-tax household income.


NatWest Bank rate targets

Image source: NatWest Markets, Bloomberg.


The Bank of England will therefore factor in the delayed impact of rate hikes on mortgage repayments in assessing policy parameters.

Walker notes that most fixed rate mortgage products are typically set for a relatively short period of 1-3 years.

“Resetting so frequently means reports of the death of monetary policy tightening are greatly exaggerated,” Walker said.

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