An influential economic research firm predicts that interest rates will fall to 2.5 percent by the end of 2027, a much larger drop than the market consensus of 3.75 percent.
Economists at Oxford Economics believe the Bank of England will cut interest rates much more than financial markets currently forecast.
The market forecast is that rates will fall to 3.75 percent by the end of 2025, and then stabilize around that level and become the new normal.
However, Oxford Economics believes the downward momentum will continue through 2026 and 2027, with rates settling at around 2.5 percent.
Andrew Goodwin, chief UK economist at Oxford Economics, says the difference is partly due to financial markets anticipating higher inflation than they actually are, but also partly due to demographic changes.
Outlier: Oxford Economics has raised its long-term forecast for interest rates from 2% to 2.5%, but it is still much lower than markets expect.
“Over the long term, the level of interest rates tends to be determined by structural factors, such as demographics and productivity growth,” Goodwin says.
‘Before the pandemic, interest rates were very low largely because the population was aging and productivity growth was very weak.
‘Once the episode of high inflation has passed, we expect these structural factors to reassert themselves.
«It is likely that in the next decade the demographic burden will be similar to that of the pre-pandemic period, especially given that the state pension age will increase by only one year.
“And while we believe advances such as AI will provide some support, we believe productivity growth is unlikely to return to the much higher rates the UK used to achieve before the global financial crisis.”
Oxford Economics’ latest projection is slightly more cautious than it forecast last year. Just a few months ago, it suggested that interest rates would eventually fall to 2 percent in 2027.
He says the recent change to UK tax rules in October’s Labor budget suggests policy will be more flexible in future.
He also expects the new US political landscape to mean higher and more volatile inflation around the world, which will put a bit more upward pressure on rates.
What would this mean for mortgage rates?
If Oxford Economics’ forecast turns out to be correct and rates hit 2.5 percent by the end of 2027, what would happen to mortgage costs?
Fixed mortgage rates are determined by swap rates, rather than the central bank’s base rate.
Swap rates reflect market expectations about future interest rates and play a key role in how lenders price fixed mortgage products.
Currently, fixed rate mortgages have taken into account future falls in interest rates, but nothing comparable to the extent predicted by Oxford Economics.
If its 2.5 percent forecast proves accurate, it could have significant implications for fixed-rate mortgages, according to Nicholas Mendes, mortgage technical manager at broker John Charcol.
“Fixed mortgage rates are typically quoted at a premium to swap rates, reflecting lender costs, risk considerations and profits,” he says.
‘If swap rates align with a 2.5 per cent base rate environment, fixed mortgage rates would likely fall below 3 per cent.
“However, individual circumstances, broader market conditions and lenders’ policies will influence the exact rates available.”
Mendes believes lender appetite will also play a big role in determining where fixed mortgage rates will value in the future.
“As the market stabilizes, consumer confidence usually recovers, which helps boost real estate prices,” adds Mendes.
‘In a more stable market, lenders’ attitudes toward pricing may change compared to trends seen over the past two years.
‘During this period, the market has been challenging, with lenders competing aggressively for business in a stagnant environment characterized by lower levels of mortgage applications.
‘Going forward, while lenders will continue to try to attract borrowers, the degree to which they are willing to compress margins may change.
“It will be interesting to see how lenders balance their appetite for business while maintaining margins in a more stable environment going forward.”
However, Andrew Goodwin at Oxford Economics believes fixed rate mortgages will not decline any time soon.
“A lower policy rate from the Bank of England should eventually translate into lower mortgage rates for UK homeowners, but not yet,” says Goodwin.
‘Financial markets believe that bank rates will stabilize at a much higher level than Oxford Economics predicts and, if we are right, it is likely to take some time for markets to adjust to our thinking.
“It will likely be a couple of years before mortgage rates fall below 4 percent again.”
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