Mortgage rates have increased sharply in recent weeks, even though the Bank of England has kept its base rate unchanged at 3.75%. The average rate on a new two-year fixed-rate mortgage rose from 4.78% on 16 January to 5.20% by mid-March, according to Moneyfacts. The key driver is not the base rate but swap rates, which have been pushed higher by geopolitical tensions and changing inflation expectations.
Swap rates are financial instruments used by banks to manage the risk of interest rate fluctuations. Lenders borrow money at variable rates to fund mortgages, then enter into swap agreements to exchange those variable payments for fixed ones. The fixed rate in a swap reflects market expectations for future base rates. When investors anticipate higher rates, swap rates rise, making it more expensive for lenders to borrow and leading to higher mortgage rates for consumers.
The recent spike in swap rates follows US and Israeli airstrikes on Iran, which have triggered economic shocks globally. Stock markets have fallen, and oil and petrol prices have risen. Analysts now expect inflation to increase again, reversing earlier forecasts of a decline. This has led markets to price in a possible Bank of England rate hike, rather than the two cuts previously anticipated for this year.
Five-year swap rates jumped to 4.03% on 17 March from 3.603% on 2 March, a significant move according to Moneyfacts' Adam French. The higher swap rates directly translate into increased costs for fixed-rate mortgages, as lenders pass on the higher cost of borrowing. Housing market analyst Neal Hudson notes that swap rates also reflect heightened economic uncertainty, which further pushes up the cost of fixed-rate lending.
