Could swap rates foretell of interest rate drops to come?
This article was produced in partnership with Lendinvest
The IMLA’s recent publication “The new ‘normal’ – prospects for 2024 and 2025” offers a detailed landscape of the mortgage market. Market-moving events such as the September 2022 mini-budget and Russian invasion of Ukraine are hailed as contributors to a struggling property market, but let’s take a moment to spotlight an area that needs more attention: swap rates.
Despite exploring the downturn in lending and the shrinking buy-to-let market over the course of 2023, the report somewhat glosses over the pivotal role of swap rates in shaping this environment, which warrants a deeper dive to truly understand their impact on the mortgage market in the last year and what lies ahead.
Why are swap rates important?
Swap rates play a crucial role in impacting mortgage rates due to their function as a key indicator of lending costs in financial markets. When swap rates are high, it suggests that the market anticipates an environment whereby interest rates are either increasing or holding firm at a relatively high level. Conversely, lower swap rates indicate expectations of falling interest rates.
This expectation is crucial for mortgage lenders. Lenders use swap rates as a benchmark to set their own interest rates for fixed-rate mortgages. Essentially, swap rates provide a reference point for the cost of securing funds over a fixed period. If swap rates rise, the cost for lenders to borrow money increases, and they typically pass on this increased cost to consumers in the form of higher mortgage rates. Similarly, when swap rates fall, the cost of borrowing for lenders decreases, often leading to lower mortgage rates offered to customers.
A closer look at the report
While the report projects a further dip in gross mortgage lending for 2024 and 2025, this forecast could be enriched by considering the recent behaviour of swaps in the capital markets.
Despite the Bank of England holding the base rate steady at 5.25% since August 2023, we’ve seen a key shift in swap rates. The one-year swap rate has dropped to 4.77%, a stark contrast from its July peak of 6.09%, and an indication that the rate hikes experienced over the course of 2022 and 2023 have ceased with the expectation that interest rates will begin to fall in 2024. Even more telling is the significant drop in the five-year swap rate to 3.60%. This pattern is signalling a potential downward shift in mortgage rates.
Contrary to the IMLA’s expectation of persistently high rates, these swap rate trends hint at a future ease in mortgage rates, perhaps earlier than anticipated. It’s an optimistic sign, suggesting that the lending environment in early 2024 might be more borrower-friendly than forecast. It is, however, worth noting that swap rates are subject to volatility in light of economic data points including, but not limited to, inflation, employment and GDP.
What’s ahead: Swap rates and mortgage rates in 2024
As we look forward to early 2024, the downward trend in swap rates, especially the five-year swap now at 3.6%, paints a hopeful picture for mortgage rates. This steady decline over several months points towards lenders accessing cheaper funding sources, which could translate into lower mortgage rates for borrowers. This scenario offers a more positive outlook than the IMLA report’s prediction, possibly leading to a rejuvenation in the mortgage market.
The IMLA report is insightful, but it’s essential to shine a light on the influential role of swap rates. Their recent decline, coupled with a stable base rate and a dip in inflation, suggests a potential softening of mortgage rates sooner than we might think. This development could create a lending environment, encouraging both lenders and borrowers to stay attuned to these trends for a comprehensive understanding of the mortgage market’s future dynamics.
