Global interest rate cuts are finally coming to fruition. The most important last week was the European Central Bank (ECB), which for the first time reduced its rates before the United States Federal Reserve.
The Bank of Canada also took action, and while markets don’t expect the Federal Reserve to change anything at its meeting this week, a Reuters poll of economists suggested it would make two cuts this year, the first in September.
And here? Well, there is a strong case for the Bank of England to make its first cut this month. Inflation in May is expected to fall to or near 2 percent, and in April, 2.3 percent, was already below the latest eurozone figure of 2.6 percent.
In the US it’s 3.4 per cent, so despite all that talk about the UK being an inflation outlier, we’re doing relatively well now.
Will the Bank move? There is a convention that central banks do not make policy changes in the run-up to elections, but that did not stop the ECB in the middle of the European Parliament elections.
Decision time: There is a strong case for the Bank of England to make its first interest rate cut this month
In any case, the Bank is supposed to be independent of politics. Sir Dave Ramsden, deputy governor for Markets and Banking and the most market-savvy member of the Monetary Policy Committee, voted for a cut last time. I would trust his judgment and would like to think he will tip the balance at the Thursday meeting of the week. But we’ll see.
Of course, in the bigger picture, the precise timing of cuts is much less important than the general characteristics of the interest rate cycle. The question is how much it will cost to renew a mortgage in two years, not whether the Bank will cut interest rates this month or in early August.
Here we embark on a journey into the unknown, but we can say a few things that will help guide us. One is that interest rates will generally reflect inflation. In the 1970s and 1980s, when there was double-digit inflation, there were double-digit interest rates.
Another is that the near-zero rates of recent years have never happened before and, given what they did with inflation, won’t happen again. A third is that there will still be some inflation in the future and keeping it under control will be a constant battle. Expect it to continue to perk up again.
Finally, governments around the world are hugely in debt, so they will compete against the rest of us for funds. That will put a floor on long-term interest rates.
It’s pretty clear that the world is now on a downward path for short-term interest rates that will last a couple more years. They don’t need to be as high as they are now to keep downward pressure on inflation, so they will be a little lower in a year or two. What is less certain is how high bond yields must be to persuade people to finance national governments.
You can see how sentiment has swung wildly over the past year by looking at ten-year bond yields. A year ago they were about 4.2 percent, practically exactly where they are now.
However, they have since peaked at nearly 4.75 percent in the fall, before falling below 3.5 percent in late December. This is a big move for a market that size.
Similar swings in the five-year rate were reflected in the way the cost of five-year fixed-rate mortgages also changed.
What the Government has to pay affects what everyone else has to pay and, while we may feel we should have a better credit rating than Her Majesty’s Government, that is not how the world works.
But that experience is a very crude guide for home buyers. Yields on Gilts (or UK government bonds) need not be much above 5 per cent, and probably won’t fall much below 3 per cent.
So if they’re at the high end of that range, it’s not a good time to get a fixed-rate mortgage.
And if they’re towards the end of that range, get one while supplies last.