Interest Rates and Investment in 2024

High interest rates have had a pronounced effect on the UK property market in 2023 and, for investors, an important question is how they might change in the year ahead.

At the most recent meeting of the Bank of England’s Monetary Policy Committee (MPC), its members voted – by a narrow margin of 5 to 4 – to keep the base rate of lending unchanged at 5.25%. This marked the first time since November 2021 that the MPC had met without raising the Bank Rate. Prior to the announcement (20 September 2023), it had raised it 14 times in a row.

Investors welcomed the news, essentially because of what it might signal. In itself, 5.25% still represents a 15-year high, and the Bank of England has said that it expects the rate to remain elevated for some considerable time yet. In other words, the present conditions remain challenging, but the mere fact that the MPC chose not to raise the Bank Rate last month gave investors grounds for optimism.

One reason for that optimism is that the decision supports a growing belief that interest rates may already have peaked, and that lower rates will prevail in 2024 and beyond. Another is that even if the official Bank Rate remains high, there is already an expectation amongst lenders of a gradual return to better rates. In turn, this has prompted them to offer increasingly competitive fixed-rate products of their own, so for borrowers in the real world, mortgage rates have already begun to fall.

In this article, we’ll consider whether such market optimism looks to be well founded, and how any future decisions on interest rates might affect the UK property investment market next year.

Interest Rates and Inflation

First, it’s important to recognise why the Bank of England has been so anxious to raise the cost of borrowing. Fundamentally, it has been using the base rate as a tool with which to try to reduce the UK’s very high rate of inflation.

For most of this year, inflation in Britain has been higher than in other G7 nations and, indeed, higher than in the majority of G20 economies. Moreover, the Organisation for Economic Co-operation and Development (OECD) believes that Britain will continue to see some of the highest rates of inflation for the rest of the year.

To address that, the MPC has sought to limit the flow of money by making it more expensive to borrow and more rewarding to save. The argument goes that with less money in circulation, people will have less available to buy goods and services, and as a result of their more limited budgets, they will become more price conscious. By the same token, if vendors want to continue to attract custom, they will have to become more competitive on their prices. The net result should be lower inflation.

That’s the theory, at least, and since the Bank of England has very few other tools at its disposal, raising the official Bank Rate has been its favoured option.

Fortunately for investors, inflation has started to fall. Some of that might be the result of the Bank’s monetary policy and some of it has certainly been the result of international factors, such as the falling price of certain foods and fuels. In any event, lower rates of inflation are very welcome because they suggest that the measures are working. And because the effects of those monetary control measures tend to lag by a few months, the MPC will not wish to over-correct and risk damaging the economy by keeping the rate higher than it needs to be.

Interest Rates and the Economy

An important point here is that it isn’t just ordinary household consumers who borrow; businesses also borrow in order to invest. If the cost of borrowing rises, companies will tend to invest less and therefore grow more slowly. And if higher interest costs erode their profits, they may well be less inclined to risk expenditure on new activities, research, equipment and jobs. As a result, higher interest rates can eventually lead to poorer economic growth and higher unemployment – two significant risks that will always weigh heavily on the MPC’s decision-making.

Looking at the current state of the UK economy, growth forecasts look decidedly downbeat. The OECD predicts that the UK’s economic growth will be the second weakest in the G7, and UK labour market statistics, published by the House of Commons in September 2023, indicated that:

“In May to July 2023 the labour market continued to loosen: employment fell, and unemployment and inactivity rose. Vacancies fell on the quarter in June to August 2023, as they have every quarter since March to May 2022.”

House of Commons Library, 12 September 2023.

On the face of it, this is hardly positive news, but it has an upside for investors. Facing the gloomy prospect of low productivity and falling employment, the Bank of England will be wary of making the situation any worse by increasing companies’ borrowing costs. This might well have been one of the factors that the MPC committee members considered when they voted in favour of keeping the base rate unchanged.

On paper, a combination of falling inflation and a faltering economy undermines the case for any further rise in interest rates. That’s no guarantee that it won’t happen – the MPC has been careful not to rule it out – but if inflation keeps falling towards its 2% target, then there is less pressure to take such an economic risk.

The Bank of England’s Governor Andrew Bailey said he is determined to bring inflation back down to target. Significantly, however, he has said “the job isn't done yet,” and has been quick to stifle speculation about any imminent cut in the base rate. Speaking in September, he said: “We have not had any discussion on the Monetary Policy Committee about reducing rates because that would be very, very premature.”

However, the fact that talk is now of rate-cuts, not rate-rises, suggests an improving outlook. That’s something that lenders have been monitoring very carefully and that, in itself, has important consequences for investors.

The Base Rate and Mortgage Interest Rates

When lenders decide whether or not to offer a mortgage, they do so on the basis of a calculation that balances risk, profitability and competitiveness.

To fund their lending, they often borrow money from financial institutions such as pension funds and, consequently, the lenders themselves will have to pay interest. On longer-term fixed-rate deals, they need to be confident that the interest payments they receive from their mortgage holders will be more than they (i.e. the lenders) will have to pay out. This, essentially, is why the subject of “swap rates” has become so prevalent in the news media over recent months.

Swap rates are an arrangement by which two financial institutions agree to swap interest rate cashflows for a given time – e.g. 3 or more years. One party agrees to take a fixed payment and the other agrees to take a variable rate payment. To apply that to an example of a typical mortgage deal, a financial institution will lend money to a bank on the understanding that the bank will pay a variable rate of interest, as determined by the official Bank Rate. Having received that money, the bank will then lend to a mortgage applicant at whatever fixed rate it is prepared to offer.

In agreeing to do this, the bank is assuming that the mortgage holder’s repayments over the lifetime of the fixed-rate deal will be more than the bank itself has to repay to its funding source. The difference between the two is essentially the bank’s profit.

This matters to investors because lenders now expect that swap rates will gradually fall. Their market confidence is growing because they believe that their profit margins will gradually improve as the base rate declines. In turn, that expectation affects their calculations about what rates they can afford to offer their customers. On the basis of their predictions about interest rates, many of them have felt able to offer mortgage deals at below the official Bank Rate. In fact, some fixed rate buy-to-let products are now available at well under 5.0%. 

The Future Direction of Interest Rates

There is, of course, no certainty when it comes to predicting economic movements. Events such as the Covid pandemic and Russia’s invasion of Ukraine are clear examples of external factors that can change a country’s economic outlook with little warning. 

However, the long-term outlook for interest rates does seem to be relatively good. Banks and building societies certainly seem convinced that rates are set on a downward path, and that’s encouraging because gauging such issues is absolutely central to their business models. But more than that, the logic behind their expectations is also very clear. 

First, inflationary pressures are easing. They may be easing faster in the EU and other developed economies but when prices moderate in other countries, that also helps to reduce the prices Britain has to pay for its imports. That has numerous knock-on effects that help to bring down our own rate of inflation.  

The Bank of England has said that it expects inflation to hit the 2% at some time in 2025. Current indicators suggest that the country is on track to achieve that; in fact, two of the most recent Consumer Price Index reports revealed that inflation was actually falling faster than predicted. This should give the Bank of England further confidence that its monetary policy has been working and that no further rises are required. 

It must also be acknowledged that forecasts for the UK economy still look bleak in comparison to other developed nations. This, again, is an argument not to raise the base rate any further because to do so would risk stifling any recovery. 

Opinions still differ, of course. The International Monetary Fund recently published a report predicting that, in 2024, the UK would have the highest inflation and the slowest growth of any G7 economy, and that the base rate would stay around 5% until 2028. However, the UK government rubbished the suggestion, saying that it failed to take account of a faster-than-expected fall in the rate of inflation and ignored the Office for National Statistics’ recently upgraded assessment of the UK's economic recovery after the pandemic.  

The debate continues but property investment is a long-term undertaking and over the timescales that count – 3, 5 or 10 years or more – it seems clear that everyone expects inflation and interest rates to decline. It doesn’t seem to be a matter of if but when. 

Interest Rates – Historic Context

In comparison to the last 15 years, today’s interest rates appear very high. Between March 2009 and March 2022, for example, the official Bank Rate remained consistently under 1.0%. However, these rates were, themselves, extremely unusual in a historical context. The chart below, which is based on data from the Bank of England, shows that between the 1950s and the global financial crisis in 2008, the base rate generally stayed well above 5%, peaking at 17.0% in November 1979.

The fact that interest rates are now closer to the longer-term UK norm does not imply that the mechanics of the housing market are in any way ‘broken.’ For decades, the market produced solid capital growth when interest rates were much higher than they are today.

When it comes to market confidence, affordability matters more than interest rates per se. It’s certainly true that concerns over interest rates have seen sales activity fall in recent months but affordability is now improving for a number of reasons.

First, average earnings have risen faster than the rate of inflation, so people are seeing a real-terms increase in wealth. Second, house prices growth has remained well below the rate of inflation, so the real-terms cost of property has fallen. And finally, of course, mortgage rates are beginning to fall, so buyers are now able to lock in to more competitive rates than they could have done just a few months earlier.

Re-Mortgaging Options

When interest rates are falling, as they are now, investors often face a dilemma. They may want to invest sooner rather than later in order to take advantage of more affordable asking prices but, equally, they may worry about missing out on better mortgage deals by acting too soon.

This is an inevitable consequence of any period when the affordability of property is improving but the cost of borrowing is falling. No one can be certain of exactly the right time to buy but it’s important to remember that buy-to-let mortgages are not lifetime commitments. They last for fixed periods, after which, the investor can take out a new mortgage and, if the base rate has fallen by that time, the investor can lock into a better deal for another fixed period.

Lenders are typically very keen to win business in the re-mortgaging market and it’s here that some of the market’s very best deals are to be found. A succession of lenders have introduced increasingly attractive products in recent weeks and, amid fierce competition to win business, investors can be confident of being offered excellent terms whenever their fixed-term deal come up for renewal.

Uncertainty about future interest rate changes are not a good reason to postpone an investment decision, not least because there is a wealth of shorter term fixed-rate deals available and because re-mortgaging will always be an option later on. On the contrary, delays in decision-making could mean missing out on some excellent opportunities during a period of improved affordability, before house prices return to their longer-term upward trend.

Conclusion

There is no consensus as to exactly where interest rates will stand in 2024. However, it seems clear that they will continue to fall slowly as inflation heads back towards the Bank of England’s 2% target. That process could take two years or more but, in the meantime, it’s fair to say that things are moving in the right direction, and that the outlook for investors is improving.

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 To find out more about investment opportunities in residential markets across the UK, please call our advisory team on 01244 343 355.