We look at whether interest rate movements behind the scenes are good or bad news for savers, those retiring, and people looking for a mortgage
The Bank of England base rate has been stuck at 0.5% for more than four years now, and outgoing Bank boss Mervyn King has indicated it won’t be going up any time soon. But, behind the scenes, some of the other interest rates that have a big impact on the financial products we buy have been shooting up in recent weeks – which in theory should mean good news for long-suffering savers and people buying a retirement annuity, but bad news for those planning to take out a cheap fixed-rate home loan.
One leading mortgage expert has declared that time could be running out to grab a record low fixed-rate mortgage, particularly if you are after a five-year deal. “I think we’ll look back on June 2013 and say, ‘That’s when fixed rates hit bottom’,” Ray Boulger, of broker John Charcol, told Guardian Money.
It’s all to do with what’s happening with money market “swap rates” and gilt yields. Swap rates are the rates banks pay to borrow from each other, and determine the pricing of fixed-rate mortgages and fixed-rate savings bonds. These have increased sharply in the past few days, with the five-year rate leaping from 0.93% at the start of May to 1.85% on 25 June. . It’s a similar story with two- and three-year swaps.
Meanwhile, gilt yields – the interest rate on UK government bonds – have also risen dramatically, particularly after global stock markets took fright just over a week ago when the US Federal Reserve rattled investors by signalling an end to America’s recession-busting “quantitative easing” programme. These also feed through to many financial products – for example, rising gilt yields should lead to rising annuity rates, which dictate how much income someone will get from their accumulated pension pot.
However, it is, of course, never as simple as that, because many other factors affect pricing. Here we look at what’s been happening and what it may mean for consumers.
Some borrowers have been able to take advantage of record low mortgage rates as a result of banks and building societies using cheap money from the government’s Funding for Lending scheme to launch highly competitive deals.
A few days ago, Yorkshire building society cut its five-year fix to just 2.44%, though this mortgage is for those borrowing no more than 65% of the property’s value (there is a £1,475 fee to pay). For someone borrowing 90%, however, one of the best five-year fixes is Nottingham building society’s 4.39% deal with a £299 fee.
Higher swap rates should mean lenders start whacking up the cost of new fixed-rate mortgages – but, so far, there is little evidence of this. The average new five-year fixed-rate mortgage was priced at 4% at the start of April, 3.96% a month later, and just 3.85% at the end of June, according to financial data provider Moneyfacts.
“We’ve seen a few mortgage lenders put their rates up, but most haven’t. Partly this is because lenders have access to cheap money from Funding for Lending,” says Boulger. He adds: “I think that because swap rates and gilt yields have gone up so fast, it would be very surprising if we don’t see more lenders increase their fixed rates – particularly their longer-term fixes.”
He says his message for those who may have been holding off buying a fixed-rate deal in the hope of further price falls is: “I think we have now hit bottom.”
Jonathan Harris at rival broker Anderson Harris says that despite the significant jump in swap rates over the past few days, “it is important to remember that lenders are not relying wholly on the money markets for funding.
“Many are accessing the Funding for Lending scheme, which means cheaper funds, and rising swaps will not affect this. However, borrowers looking for a fixed rate might want to consider moving sooner rather than later as there are no guarantees that rates will be around in a few weeks, no matter what happens to swaps,” he adds.
Rising swap rates should be good news for savers, as they affect the levels at which fixed-rate savings deals are offered. But, as Moneyfacts said this week, it is not making an impact as yet. That’s partly because Funding for Lending has made banks and building societies less reliant on pulling in savers’ cash to finance the loans they make. But the higher rates may start to feed through in the coming weeks.
The average five-year fixed-rate savings bond was paying 2.45% at the start of April, and 2.46% at the beginning of May, but at the end of June the figure stood at 2.27%. Average rates on two- and three-year fixed-rate bonds are also down – to 1.9% and 2.08% respectivelyin late June, from 2.07%/2.17% in April.
The best-paying five-year fixed-rate bonds are currently from smaller or less well-known players (2.9% from FirstSave, 2.75% from ICICI Bank UK and Shawbrook bank, 2.56% from Vanquis bank), and it’s a similar picture with two- and three-year accounts.
Rachel Springall at Moneyfacts says that regardless of swap rates, savings rates are still going down. However, Peter Hill, chief executive of Leeds building society, says that if swap rates continue to rise, particularly for longer terms, “the good news is that this may provide savers with the opportunity to lock into some positive returns”.
There was a sliver of good news this week when the Post Office launched some online fixed-rate bonds, including a one-year account paying 1.99%, a two-year product paying 2.1% and a three-year offering 2.2%, where the minimum investment is £500. The one-year account is only beaten by State Bank of India UK, which is paying 2% – but with a minimum deposit requirement of £10,000.
Gilt yields have shot up lately, particularly in the wake of concerns that the Federal Reserve will soon begin winding down its quantitative easing programme. The 15-year gilt yield has risen from 2.2% on 2 May to 3% on 26 June.
When yields are rising, annuity rates should rise too, says investment and pension firm Hargreaves Lansdown but, it adds, there is no guarantee that annuity rates will respond immediately or proportionately, as the link between the two is far from perfect. Head of pensions research Tom McPhail said: “It is unrealistic to expect a sudden short-term jump in gilt yields to feed through immediately into higher annuity rates. However, if this new pricing environment for gilts persists, then an annuity rate increase may be on the cards.”
An annuity provides a regular income from the pot of money a pension plan holder has accumulated, but rates have collapsed in recent years. This week, the benchmark annuity rate for a 65-year-old man was up by about 1.7% since the start of May, says Hargreaves Lansdown. Companies that have hiked their annuity rates during the past fortnight include Aviva, Prudential and Canada Life. We asked Aviva and Legal & General to give us an idea of how much a 65-year-old non-smoking man living in north-east London with a £100,000 fund might receive: Aviva would pay him £5,931 a year, while L&G said £5,669 (both assume a single life and no annual increases in income).
But bear in mind that while rising yields might be good for annuity rates, they spell bad news for the pension funds of many people approaching retirement. That’s because many company pension schemes and stakeholder plans switch workers’ savings into less volatile investments such as UK gilts and corporate bonds as they approach retirement, to protect them from stock market falls – a process called “lifestyling”. In recent years this strategy has proved hugely successful, with bond prices surging on the back of the financial crisis and quantitative easing. But with bond prices slumping in recent weeks, particularly after the Fed’s comments, lifestyle pension funds had, by 26 July, fallen by 7.7% on average since the start of May, according to Hargreaves Lansdown.
So what should people do? Hargreaves’ Laith Khalaf says: “Investors should review their pension plan to see if it includes lifestyling and decide whether this is appropriate for them. If not, they may consider investing elsewhere. Cash may not return much but it will hold its nominal value, a feature not to be sniffed at when approaching retirement.”
So is now the time to take out an annuity? Well … no one knows which way rates are going to go but if you need income now, you don’t have much choice. Some people might want to put off buying an annuity in the hope rates will improve, but that of course means losing out on income during that period. Another option would be to buy some annuity now, and some later.
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