Lately, there have been discussions about the possibility of a banking collapse, fueled by the collapse of Silicon Valley Bank and the troubles faced by Credit Suisse. However, most experts agree that these issues are quite different from the financial crash and are unlikely to result in a “contagion” that would impact other retail banks.
Surprisingly, the collapse of Silicon Valley Bank has caused swap rates to drop by 0.4% since Thursday’s close, which might benefit borrowers as rates could decrease sooner than anticipated. With another Bank of England base rate increase expected, what does this mean for interest rates? Will they rise or fall? This is the crucial question many clients are asking, and the answer can be quite complex.
What are swap rates?
To better understand the situation, let’s first examine swap rates and their impact on UK mortgage fixed rates. Swap rates involve an agreement between two parties who agree to exchange one series of future interest payments for another, based on a specified principal amount. Mortgage lenders use these rates to mitigate the interest rate risk associated with fixed-rate mortgages. In this arrangement, one party receives a fixed-rate payment, while the other gets a variable-rate payment. Swap rates essentially help balance risk, as mortgage lenders need stability when agreeing to long fixed terms with their customers. By “selling” some risk to another party, lenders can receive a larger payment in return, with the understanding that their rates might increase.
What about the BoE rate?
Now, let’s consider the Bank of England Base Rate. This rate determines the interest that commercial banks must pay when borrowing money from the Bank of England. The base rate also affects ‘Swap’ rates, which are the interest rates banks charge when lending to each other. When the base rate changes, lenders often adjust their interest rates on loans or savings products for consumers accordingly.
So, what does this all mean for UK mortgage rates? Mortgage lenders rely on swap rates to set their fixed rates over longer periods. Although swap rates are more volatile than the Bank of England rate, they are still influenced by it. Lenders have likely factored in larger rate increases from the Bank of England than what we may actually see. In this unusual situation, a banking crisis might actually benefit mortgage customers.
Alex Maddox, capital markets and digital director at Kensington Mortgages, recently shared some good news with Mortgage Solutions. He mentioned that the UK rate curve has shifted dramatically, with the two-year swap rate dropping from 4.6% to below 4% between Friday and Monday, currently trading around 4.25%. Consequently, markets now expect the Bank of England to increase its base rate in 2023 by only 30 basis points, compared to the 70 basis points expected last Friday.
As a result, we may continue to see UK mortgage rates decreasing, as lenders become more confident about their profit margins and the extent of future rate increases, allowing them to offer loans at more affordable rates. However, it is essential to note that UK mortgage lenders have been operating with slim profit margins for a while and may be hesitant to revert to ultra-low rates. Therefore, it is doubtful that we will see sub-4% mortgages for most people this year.