Jump in funding costs threatens recent mortgage rate falls and dials back expectations of Bank Rate cuts
Lenders are expected to pull and reprice fixed-rate products in the coming days after a sharp rise in gilt and swap rates, driven by renewed tensions involving Iran and a rapid shift in market expectations for Bank of England policy.
Two-year gilt yields are around 21 basis points higher at roughly 4.08%, while five-year yields are about 16 basis points up at around 4.27%, increasing funding costs that underpin fixed-rate mortgage pricing and reducing the likelihood of multiple base rate cuts this year.
“Mortgage rates had been gradually edging down over the past few weeks as markets priced in a series of Bank of England rate cuts later this year,” said Nicholas Mendes, mortgage technical manager at London broker John Charcol. “The escalation in tensions involving Iran has shifted that tone quite quickly, as financial markets tend to react rapidly when geopolitical risk feeds into inflation expectations.”
Mendes (pictured right) noted that the latest geopolitical flare-up has pushed oil prices higher, even after some intraday retracement. Crude remains a little above $100 a barrel and roughly 10% higher overall on the day, reinforcing concerns that energy costs will again feed into inflation expectations.
He pointed out that energy markets are often the first channel through which geopolitical risk is reflected in inflation forecasts, and that this has fed directly into government bond and swap pricing. As gilts and swaps are central to lenders’ hedging and wholesale funding, the move higher is already forcing a reassessment of fixed-rate product ranges that had been priced off lower curves only recently.
“As a result, we’re likely to see another wave of lenders withdrawing or repricing deals over the coming days, including some who only increased rates last week,” Mendes said. He added that when underlying funding costs shift this quickly, lenders tend to react promptly as existing hedges roll off and they seek to protect margins.
The repricing in swaps has also altered the interest rate outlook implied by markets. Traders had previously been factoring in several Bank of England rate cuts over the course of the year, helping to support the recent downward drift in mortgage rates.
“At this stage, we are closer to a scenario where perhaps only one cut materialises across the year, rather than the series markets had anticipated a few weeks ago,” he said.
For advisers working with borrowers approaching the end of their current deal, Mendes stressed that recent events underline how fast mortgage pricing can move when markets are volatile.
Many lenders allow customers to secure a new rate several months ahead of maturity. Mendes said that brokers can use this window to reserve a product now, then keep reviewing the market and switch to a cheaper rate if terms improve before completion. Locking in early, he suggested, can operate as a form of insurance if funding costs continue to rise or if geopolitical risks remain elevated.
“For buyers, the wider economic backdrop may also start to play a role,” Mendes suggested. “If higher inflation and borrowing costs begin to weigh on economic activity, the combined effect can start to cool property price growth. That can sometimes give purchasers more room to negotiate, particularly if sellers become more realistic about the market conditions ahead.”
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