The Bank of England has reduced the base rate for the second time this year, so there’s a good chance you’ll be speaking with customers who expect that mortgage rates will automatically follow suit.
Contrary to what we once may have believed, however, the link between the base rate and mortgage rates isn’t straightforward. In fact, a base rate cut can have little to no direct impact on mortgage pricing.
Understandably, this can sometimes feel confusing for customers and brokers. I will put my hands up, I hope rates reduce aligned with the base rate, but unfortunately, recently, this has not been the case.
Here’s a breakdown of why mortgage rates don’t always fall in line with the base rate cuts, and some tips on how you can explain this to your customers.
For most lenders, mortgage pricing hinges on SWAP rates rather than the base rate, as these allow lenders to fix their own funding costs over time, which is essential for offering competitive fixed-rate products. SWAP rates are based on future market expectations of interest rate trends, not the current rate set by the central bank.
A decrease in the base rate might not shift SWAP rates downward if the market believes the rate drop is temporary or if inflationary pressures are expected to persist. This means that SWAP rates may remain elevated – or even increase – despite a cut in the Base Rate.
Current market conditions have only amplified this disconnect. Recent global events and domestic economic factors, such as the recent Budget announcement, political developments abroad like the US election, or the collapse of the German coalition Government have led many in the market to adjust their expectations for future interest rates.
Markets are now factoring in the possibility that interest rates may stay higher for longer than initially anticipated – and this means that despite the cut in the base rate, SWAP rates have actually increased rather than fallen. This impacts lenders’ funding costs, which naturally affects mortgage pricing.
As a broker, it can be important to explain these dynamics to customers, which can help manage their expectations and increase the appreciation of your expertise. Many will assume that a lower base rate should mean an immediate drop in mortgage rates, so you may need to help clarify why mortgage rates are influenced by broader, more complex factors.
A few points to communicate with customers can include explaining how mortgage rates are guided more by SWAP rates, and how global economic events – like fiscal policies or international political developments – can drive SWAP rate changes. By highlighting that SWAP rates reflect market expectations of future rate movements, you can help customers understand why a Base Rate cut doesn’t necessarily mean mortgage rates will decrease.
Helping to raise customer understanding in this way not only helps to manage their expectations, but it can also position you as a knowledgeable, trusted partner, especially in an environment shrouded in so much uncertainty. This can help you to develop and maintain stronger, long-lasting customer relationships.
Rob Barnard is relationship director at Pepper Money
