Negative Interest Rates in the mortgage world?
The big news from last week in the mortgage world (if you discount Iceland sending a Chicken Nugget into space that is…) was the increased chance of seeing negative interest rates in the UK for the first time ever. As this is potentially such a big move and change in stance, it does require further explanation:
Why is this is hot topic now?
Last week Sam Woods, Deputy governor of the Bank of England, wrote to financial firms for them to assess their readiness for negative interest rates.
The letter reads: “For a negative Bank Rate to be effective as a policy tool, the financial sector – as the key transmission mechanism of monetary policy – would need to be operationally ready to implement it in a way that does not adversely affect the safety and soundness of firms. This engagement is not asking firms to begin taking steps to ensure they are operationally ready to implement a negative Bank Rate.”
What is the likelihood of it happening?
If I were a betting man (and I am) I would not be putting money on negative interest rates anytime soon. The reason for this is twofold;
- The Statement above is very clearly looking at this from an operational standpoint, it isn’t a preparatory statement.
- Money Markets aren’t betting on this (at least not for now).
Looking at the money market data, this isn’t priced in to happen currently. You would be seeing Libor go below zero if ‘the market’ felt this was likely. A note of caution though that Libor has been inching toward zero quite consistently since lockdown (see below graph).
What effect would it have on mortgage rates?
That really is the headscratcher.
In ‘normal times’ (and a look at any news outlet will tell you we are not even close to something resembling normality), mortgage rates would go down, right down, quite likely below 1% (we have seen sub 1% rates before).
An old adage in the banking world is that lending should be at least 1% above cost of funds to make it profitable, so if say The Bank of England went to -0.5%, ‘best buy’ mortgages could conceivably be around the 0.5% mark. Or any variant thereof. That does assume a relatively normal funding model and the fact we are having a conversation of sub 0% rates means by definition this isn’t normal, so it is hard to predict.
If funding became constrained due to systemic issues in the banking system, you could well see mortgage rates go up as they did in 2008/9 even while the Bank of England slashed rates. Moves like this are often designed to counterbalance funding constraints to make the money flow more easily around the system.
As there are no funding issues at present, in fact quite the opposite, the most likely outcome is that mortgage rates would stay about where they are now, perhaps marginally cheaper. A bigger impact on mortgage rates is actually house prices. That is a very big topic I won’t broach now but in a nutshell – house prices go up, costs go down, and vice versa.
What if I have, or will have a mortgage when this happen, what impact will it have?
In all honesty, little or nothing in the short term. The vast majority of new mortgages arranged are on a fixed rate basis, so whatever happens to interest rates between now and when your deal is up, it won’t affect your payments.
Even if you have taken a Tracker mortgage it is likely that your payments wouldn’t go down if the Bank of England reduced rates as most lenders have implemented a ‘collar’ (as lenders have learned from what happened in 2008) meaning that your mortgage rate will never go below a set value (normally the rate you are currently at). However, that does mean that if rates then went back up, it wouldn’t affect you until the base rate was at least above where it is today. So overall, most differences would be felt when your current deal comes to an end and you had to remortgage.
So for the moment at least, it is looking unlikely the Bank of England will reduce their benchmark rate to 0% or below to negative interest rates. A very close eye will be kept on Libor in the short term, as if that does dip to zero or below, that is a very big tell that this move is on the cards, but as you can see on the below chart, that isn’t a guarantee it even would happen at that point.
As there are just so many complicated implications to savers, investors and pension, plus no Financial firm ever had this on their radar until now, I still think we are a way off and hopefully it won’t happen. But based on what I have seen this year, I am not ruling any lunacy out just yet!
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