Why interest rates may never fall back to recent lows and what that means for you

The era of super-cheap money is over, according to leading economists who argue interest rates will not fall back to the low levels enjoyed prior to 2022.

This week, the cost of government borrowing soared to its highest level for more than a quarter of a century, partly triggered by a global bond sell-off and Labour Chancellor Rachel Reeves’ Budget plan to borrow and spend more, while raising tax on business.

The yield on 30-year gilts reached the highest it has been since 1998, while, the yield on 10-year gilts hit the highest level since the financial crisis.

This has had knock-on effects across money markets with mortgage rates and savings rates facing an impact.

The presumption that interest rates will keep falling is now being challenged and doubts are growing over market forecasts.

No forecasters expected rates to fall as far as the lows seen in the financial crisis and Covid pandemic years. But now the bottom of the rate cycle is seen as higher and borrowers are being warned they need to adjust their expectations.

What is happening to interest rates?

This time last year, the general consensus was that the Bank of England would cut interest rates up to six times in 2024.

But a rebound in inflation, strong wage growth, a resilient economy and low unemployment resulted in the Bank of England only cutting twice last year.

Markets are now predicting the central bank will cut rates three times this year to finish up at 4 per cent by the end of 2025.

Some banks are more optimistic. Santander predicts interest rates will fall to 3.75 per cent by the end of this year while Barclays is expecting rates to fall to 3.5 per cent by the end of December.

However, there is now every possibility rates could remain higher for the foreseeable future. 

Under normal circumstances and in the context of historical rates, a base rate of 4 per cent to 5 per cent would be considered low. However, rates were stuck at such a low level for so long, that a generation of homeowners has come of age on mortgage rates below 3 per cent – and got used to them.

The super-cheap money era 

As the financial crisis hit, the Bank of England cut base rate from 5.75 per cent in July 2007 to 0.5 per cent in March 2009 – at the time this was its lowest point in more than 300 years of bank rate history.

It did this as an emergency measure to support the economy that then stuck. Rates were cut after the Brexit vote, raised again slightly and then slashed to the bone as the Covid pandemic hit, with base rate hitting its record low of 0.1 per cent.

The Bank of Englands ratesetters may have stuck below 1 per cent for more than a decade but there is an argument that the Monetary Policy Committee would prefer equilibrium at higher rates, to ensure it has the rate-cutting tool in its arsenal if another crisis unfolds.

Paul Dales, chief economist at Capital Economics thinks the era of super-cheap money is over, albeit he still thinks the bank rate could settle as low as 3 per cent.

‘Interest rates of close to zero leave policy makers with nowhere to go if there were a recession,’ said Dales.

‘It would mean the Bank of England would not be able to cut rates further to support the economy.

‘Low interest rates – like seen prior to 2022/23 can create financial instability because it can induce excessive risk taking when borrowing is very cheap.

‘Changes in the economy mean that a more normal Bank of England base rate is probably about 3 per cent.’

Santander’s economists expect interest rates to settle between 3 per cent 4 per cent for the foreseeable future. 

Frances Haque, chief economist at Santander UK said: ‘While you can never say never, in the current environment where inflation is proving stickier, the likelihood of interest rates falling in the near-term to where they were pre-Covid, is very low. 

‘Our own forecasts continue to expect a further four cuts over the course of this year, with base rate ending the year at 3.75 per cent, and remaining between 3-4 per cent for the foreseeable.’

Barring another state of emergency, most forecasters agree that rates are not going below 3 per cent. 

What next for mortgage rates?

If interest rates are to remain high for the foreseeable future or don’t fall as far as markets currently expect, then this could mean mortgage rates actually rise rather than fall from where they are now.

Sonia swap rates, which reflect lenders’ expectations of future interest rates and play a critical role in how fixed-rate mortgages are priced.

Swaps have been rising over the past month and fixed rate mortgages, by and large, have yet to follow suit.

A month ago, five-year swaps were at 3.8 per cent and two-year swaps were at 4 per cent.

But as of today five-year swaps have risen to 4.28 per cent and two-year swaps are at 4.41 per cent.

During that time the lowest fixed rate mortgages have not risen meaning the lowest fixed rate mortgages are currently below their equivalent swaps – something that is incredibly rare.

The lowest five-year fixed rate mortgage currently pays 4.07 per cent and the lowest two-year fixed rate is 4.2 per cent.

Frances Haque adds: ‘This month, we’re already seeing swap rates edge up as they respond to volatility in the bond market, caused by an uncertain economic outlook for 2025 both at home and abroad.

‘As such, lenders may well – in the short-term – nudge up pricing to reflect the higher swaps.

‘With just less than a month to go until the next MPC announcement, all eyes are on this week’s inflation and GDP data to give some indication of how close the next cut from the Bank will be.

‘As it stands, with inflation proving to be more persistent, but with growth weakening, the MPC is likely to proceed cautiously.

‘For mortgages, this means affordability will continue to be a focus and house prices will likely reflect this going forward.’

Stuart Cheetham, chief executive of MPowered Mortgages is more confident however that mortgage rates still have further to fall.

‘Looking ahead, I expect the Bank of England’s base rate to decline significantly from its current level and, in an extreme case, drop as low as 2.5 per cent or 2.75 per cent,’ said Cheetham.

‘The good news is that mortgage rates will fall but remain higher than those seen in the past decade. 

‘The era of rock-bottom mortgage rates is well and truly over. However, borrowers should rest assured that we should start seeing mortgage rates starting with a “3” more regularly.’

What does it mean for savings rates?

Savings rates have already come down somewhat since the Bank of England initiated its first cut in August.

But savers can still get as high as 5 per cent in an easy-access account and as high as 4.5 per cent in fixed rate savings.

Any Bank of England interest rate cut would have almost immediate impact on variable savings rates such as easy-access accounts – so rates staying where they are will be good news for many savers.

As for fixed rate savings, similar to fixed rate mortgages, they tend to pre-empt changes to base rate.

And similar to fixed rate mortgages, the fixed rate savings market has lagged the move in gilt prices.

For example, while two-year gilts have increased by 0.28 percentage points since 1 January, two-year savings rates have only increased by 0.15 percentage points, according to analysis by Hargreaves Lansdown.

But pricing in the savings market is shifting with fixed rates now beginning to pay better rates than easy access rates, for the first time since 2023.

Mark Hicks, head of Active Savings, Hargreaves Lansdown said: ‘The bond drama hasn’t shifted savings rates spectacularly, but it has normalised the market – with fixed term bonds finally offering more interest than easy access accounts.

‘As gilt prices move, this affects the savings market, and it has a knock-on effect onto swap prices which affect fixed rates that banks and building societies can offer.

‘To reduce their interest rate exposure, banks will lock in fixed-term rates for savers and use swaps to hedge out their exposure.

‘However, when you compare the move in gilt prices to the top two-year fixed rate savings rate there is a noticeable difference.

‘If gilt prices stay at the levels that they are at now, or continue to sell off, we will see further increases in longer-term fixed rates.

He added: ‘One of our predictions for the savings market in 2025 is that the rate picture will start to normalise with fixed rates offering higher interest than easy access rates.’

‘The movements that we have seen in the gilt market is starting to make that prediction come true sooner than we expected.’