Base Rate Reaction

Kay McLellan

June 9, 2006

Ray Boulger senior technical director at John Charcol, commented: “For the tenth month in a row, the MPC have decided to keep rates on hold. Although industrial production and retail figures have remained reasonably good over the past month, many markets have had a very volatile period, partly because of nervousness over US interest rate policy. As today’s rate freeze was virtually a done deal, with the same again expected in July, interest will mainly be focused on the minutes, which will be released in a couple of weeks time. Of particular interest will be not only how the vote was split but also how new boy David Blanchflower voted. This, together with the general tone of the meeting, may provide a steer as to the likelihood of a Base Rate rise in August, the month of the Bank’s next quarterly inflation report.

“Previous football World Cups have resulted in a sharp reduction in some economic activity, particular house buying and remortgaging. Mortgage approvals have dropped off from the very high levels achieved in the winter and in fact the latest Bank of England figures show they are now at their lowest since September last year. Strong mortgage approvals during the winter and weaker figures now in the traditionally strong spring call into question the viability of placing too much emphasis on seasonally adjusted house prices.

“The Nationwide and Halifax house price indices are both disclosed on a seasonally adjusted basis and often the press releases don’t even contain the real figures. Seasonally adjusting the figures results in increased index levels being declared in the winter, and lower figures in the spring. (Likewise the summer and autumn.) Thus real house price growth was not as strong as the figures from both lenders suggested, but correspondingly real growth now will be a little higher. As interest rate movements are now more important than seasonal factors in influencing house prices it would be helpful when seasonally adjusted statistics are released if the real figures were given equal prominence.”

Boulger continued: “In the last month we’ve seen a flurry of activity in the tracker market with several banks and building societies coming out with some excellent value deals as the previously popular fixed-rate mortgages have slipped down the popularity list. Swap rates rose sharply in the first half of May but have since fallen back to similar levels seen at the start of that month. A major cause of the fall back in swap rates was the sharp sell off in global equity markets, especially emerging markets, from mid May and a ‘flight to quality’ with the sale proceed being reinvested in government bonds.

“Base Rate would now need to rise by 0.5 per cent before the rate payable on today’s best trackers rises to the level of the best fixed rate mortgages. For borrowers who don’t need the pay rate certainty offered by a fixed or capped rate, but would like a fixed or capped rate if they felt the rate was attractive enough, a tracker mortgage with a drop-lock option remains attractive. Drop-locks offer the borrower the option to fix their mortgage at a time of their choosing and therefore are ideal for borrowers who like the idea of a fixed rate but expect rates to fall over the next year or so.”

Mehrdad Yousefi, head of intermediary mortgages at Alliance & Leicester, said:”Despite murmurings of a rise this month, it is not a surprise that the MPC has decided to maintain rates.

“The Committee is likely to have been split in its decision on whether or not to raise interest rates despite recent credit growth in the economy. However, last month’s minutes suggest they will look to maintain rates in the short term. Most commentators agree that we are unlikely to see any movement in rates until August at the earliest, when the Bank of England issues its quarterly inflation report.

“The current stable housing market and single digit rise in house prices occurring for the first time this year further underlines the need to maintain interest rates at this stage. The decision to raise or reduce interest rates will remain finely balanced for the remainder of the year and will be subject to both economic statistics and the stability of the wider financial markets.

“Homeowners and prospective purchasers should take this opportunity to look at current tracker mortgage deals, with many deals currently priced lower than the base rate. Households on tight budgets may still prefer the certainty that fixed rates offer.”

Barry Naisbitt, Abbey’s chief economist, commented: “This marks the tenth month in which rates have been left unchanged. While financial markets are worrying about whether the US Federal Reserve is going to raise rates for a 17th successive meeting, the Monetary Policy Committee continued to hold a steadier course.

“One reason for holding rates is that the economic news over the month has again been somewhat mixed. On the upward side, for example, there have been some stronger figures within manufacturing from with the Engineering Employers’ Federation reporting that orders and output were the strongest since the mid-1990s. Against this, lower stockmarket prices and a higher value of sterling suggest some downward bias on inflation.

“The interest for commentators and financial markets will be in how the Monetary Policy Committee members voted. Last month there was an unusual three-way split in the vote. This month Professor Nickell, who voted to cut rates in May, had left the Committee, so there will be a focus on whether anyone followed his view on rates or whether more members voted to raise rates than in May.”

Milan Khatri, the Royal Institution of Chartered Surveyors (RICS) chief economist, said: “The Bank of England’s decision to leave interest rates unchanged today at 4.5 percent is welcomed by RICS, though not unexpected. The UK economy is performing well as rising global activity is helping to propel manufacturing exports and belated business investment higher. Consumer spending has lagged behind the rest of the economy, though even here there is growing evidence that households are losing their grip on their wallets as the job market picks up (almost 220,000 jobs were created in the year to March 2006). The housing market has shown some signs of cooling in recent months, with mortgage approvals dropping in April and house prices reported as flat in May by lenders. However, RICS expects the housing market to remain stable through 2006 as the economy continues to grow, providing a lift to consumer spending. RICS expects the Bank of England to follow the lead of other world central banks, and raise interest rates later this summer or autumn. A modest rise in borrowing costs is unlikely to derail the wider economy and households on tight budgets will need to factor higher interest rates into their calculations.”

John Heron, director of mortgages at specialist buy-to-let lender Paragon, said: “Landlords and the buy-to-let sector generally will warmly welcome the decision to hold rates, and indeed the increasing likelihood that rates will be held for the foreseeable future. In recent research by Paragon, landlords said that low and stable interest rates were the most important factor incentivising them to invest in rental properties, mentioned by 46 per cent of them. Similarly, 39 per cent of landlords reported that rising interest rates were the most likely factor to discourage them from investing. The MPC’s decision will be applauded by the private rented sector and indeed by the growing number of tenants who rely on it for their accommodation needs.”

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