Mortgage pain to stay as government borrowing costs hit 27-year high

Homeowners are braced to pay high mortgage rates for longer as government borrowing costs have soared.

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High government borrowing costs come amid fears that inflation is creeping up again, which could lead the Bank of England to keep rates on hold.

Economists had previously expected the Bank of England base rate, which is currently at 4.75 per cent, to start slowly falling, perhaps to as low as 3 per cent by the end of this year.

But the central bank is likely to want to hold off on more cuts if inflation starts to bite again, even though economic growth is sluggish.

Russ Mould, investment director at pensions firm AJ Bell said the markets had cut back on the number of interest rates cuts they expected this year, with most bets by traders suggesting two rather than four.

He said he “wouldn’t be shocked” if the Bank of England decided not to cut rates in February, when the next decision is due.

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“People are looking at inflation and wages,” he said. Food and energy prices are rising, which could mean higher inflation.

High inflation combined with poor growth is known as stagflation, a scenario governments try to avoid as household incomes are squeezed.

Oil prices have started to climb again, which could suggest climbing energy prices as well as pricier petrol at the pump. Brent crude has risen by 3.4 per cent since the start of the year.

Susannah Streeter, head of money and markets at stock broker Hargreaves Lansdown said that in the UK there is “particular concern brewing about stagflation taking hold, given that inflation has been creeping up and pay growth is still hot, while the economy has been stagnating. There are concerns this may limit the interest rate reductions this year.”

Long-term dated UK government bond yields are hovering near highs not seen since 1998, with 30-year debt trading around 5.24 per cent.

Government bonds dated for 10- years have also crept higher, above levels seen in October 2023 after the disastrous Liz Truss mini-Budget.

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As well as suggesting costlier borrowing for households, expensive government debt costs the Treasury more in interest payments, potentially meaning less spending on other projects or more tax is needed.

The higher cost of government borrowing is a consequence of investors selling the debt over inflation fears. Central banks use higher interest rates to try and tame inflation, limiting the chance of rate cuts.

Interest rates on home loans are influenced by a number of factors, the base rate set by the bank of England being one.

Another is competition between lenders which want more custom, which can lead to so-called rates wars, which push down prices.

A modest rates war broke out in the last week, as First Direct cut borrowing costs, albeit by just 0.3 per cent taking a five-year fixed-rate deal to as little as 4.13 per cent. First Direct followed its owner HSBC in trimming rates.

Nick Mendes of John Charcol brokers said other lenders could follow suit, although the cuts will be small. “It reflects the competitive nature of the market and offers potential savings for first-time buyers, home movers, and those looking to remortgage,” he said.

“While we’re likely to see further rate cuts over the coming weeks, these are expected to be modest, with only minimal changes to the best deals currently available.”