UK update: Interest & mortgage rates to rise further as inflation & wages remain hot

Sometimes I dream of a world where the word “inflation” appears in less than 98% of financial articles. Whether reading about macroeconomics, the stock market, obscure cryptocurrencies or house prices, it’s a good bet that the dirty topic of inflation will feature in there somewhere. 

Now over eighteen months into the deepest inflation crisis since the 1970s, my dream won’t be realised anytime soon. 

This is especially true in the UK, a country whose economy is struggling so evidently as it embarks on this post-pandemic, post-Brexit world. I wrote in April about how inflation in the UK was among the worst in Western Europe. Tomorrow, we will get the latest reading when May numbers are announced. 

The all-important Bank of England announcement will then come 24 hours later, with the market expecting a hike to 4.75% for the benchmark interest rate. 

Inflation last month fell to 8.7% in the UK. That means that, for the first time since last summer, the headline rate is not in double digits. Talk about a hollow victory. 

There is more than the headline rate to be occupied with here, however. The core inflation reading, which strips out the volatile effects of food and energy, is often viewed as a better metric for ascertaining how deeply inflation is embedded within an economy. Unfortunately for Brits, this measure jumped to its highest level in decades, up to 6.2% from 5.7% the previous month. 

This is a problem because, not only is the number shockingly high, but the trajectory is also highly concerning. Looking at expectations for Wednesday, headline inflation is expected to come in at 8.5%, a slight decline from the 8.7% last month. But this is predicated mainly on a fall in gas prices, and core inflation is expected to remain sticky and come in at the same level as last month. 

With this context, it is not clear to see why the market is near-unanimously anticipating a thirteenth consecutive rate rise from the Bank of England on Thursday, regardless of the May inflation number that will be revealed a day earlier. 

Mortgage owners to feel the squeeze

Rates have been hiked at every meeting since November 2021, when the base rate sat at 0.1%. To now be on the verge of 4.75% doesn’t exactly make for an appetising meal for mortgage owners. The cost of a two-year fixed mortgage rate rose above 6% on Monday. Even worse, two-year gilts jumped above 5%, indicating mortgage rates could go even higher again. 

This creates a nightmare scenario for many UK consumers, with thousands primed to roll off fixed-rate mortgages next year, right into the belly of this beast. With a cost of living crisis still roaring, the UK is in a bad place. The ship may have been steadied since the chaos of Lizz Truss last year, but uncertainty remains high and times will only get tougher for those facing refinancing in the near future.

Backing out probabilities from futures, the terminal rate is now expected to hit 5.75% later this year, an incredible 5.65% higher than the good old days in 2021. 

But with nearly all sectors of the economy bursting with inflationary pressure, the Bank of England has no easy way out. The most recent wage numbers, showing a rise of 7.2% on an annual basis, highlight the extent of the problem and have the market believing that higher rates are non-negotiable if inflation is ever to be slayed. 

While the US is doing far better than most European economies, with its inflation now down to 4% as of last month, the below chart paints a gruesome picture of just how badly the situation in the US has become – as well as highlighting the difference in the trajectory of the two nations, with the US seeing falling inflation since last July. 

The Bank of England is in a very tough position. They will hope the inflation numbers on Wednesday will be kind, but even if they come in better than expected, things may have to get worse before they get better. And for anyone holding a fixed rate mortgage with the clock ticking down to refinance-time, that is not a fun scenario.