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What is inflation, and how is it affecting mortgage interest rates?

Updated: Aug 3, 2023

In today's blog, Fowler Smith director, Jonathan Fowler, discusses why inflation is the one to watch at present, and how it can ultimately affect those with mortgages, and how lenders price their interest rates.


Inflation is hot topic in the media, and is a word on the mouths of many across the country.

Inflation has a significant impact on various aspects of the economy. One area that feels the effects of inflation directly is the mortgage market. As inflation rates rise, so can mortgage rates. Understanding this correlation is crucial for anyone considering a mortgage, as it can provide valuable insights into the current state and future prospects of the housing market – and this is what we're going to discuss in this blog post.

So what exactly is inflation? Inflation is the sustained increase in the general price level of goods and services in an economy over a specific period. It erodes the purchasing power of money, making it more expensive to buy the same amount of goods and services over time. Inflation is measured using various indices, such as the Consumer Price Index (CPI), which tracks changes in the prices of a basket of commonly purchased goods and services.

When inflation is higher than the comfortable target range, the cost of living also tends to increase. This means that individuals and families have to spend more money to maintain their standard of living. Rising prices can affect everything from the weekly shop to transport, making it more challenging for people to make ends meet. But how does inflation impact mortgage rates?

Mortgage rates are influenced by a number of factors. Lenders and financial institutions anticipate inflation when setting interest rates for mortgages. When inflation is high or expected to increase, lenders demand higher interest rates to compensate.

Central banks, in our case the Bank of England, play a crucial role in controlling inflation. One of their primary tools is adjusting interest rates – which we've seen very often since 2022 – naturally a big shock since the all time low figure of 0.1% introduced during the Covid pandemic.

When inflation is on the rise, central banks may increase interest rates to slow down borrowing and spending. Higher interest rates make borrowing more expensive, reducing the overall demand for loans, including mortgages. As a result, this acts as a countermeasure to control inflation by curbing excessive spending and investment – one of the Bank of England's main agendas at present.

The relationship between inflation and mortgage rates becomes particularly relevant in the current mortgage market, which has seen a series of interest rate increases. As inflation accelerates, central banks respond by raising interest rates to maintain stability and keep inflation under control.

However, while rising mortgage rates due to inflation may seem daunting to prospective buyers, there is a silver lining. Inflation is not a one-way street; it can also fall. In fact, a decrease in inflation rates can have a positive impact on the mortgage and housing market.

If inflation falls significantly, it could lead to a decrease in interest rates. Lower inflation reduces the need for central banks to hike interest rates aggressively, which can make borrowing more affordable for potential homebuyers. This can stimulate demand in the housing market and potentially lead to increased activity in buying and selling properties.

Moreover, lower inflation can alleviate the burden on homeowners who have variable rate mortgages. These mortgages are directly impacted by changes in interest rates, so when inflation decreases, if interest rates are then to fall as a knock-on effect, mortgage payments can become more manageable for those with variable-rate mortgages.

In conclusion, inflation plays a crucial role in determining mortgage rates. As inflation rises, interest rates will normally rise, making borrowing more expensive. Central banks monitor inflation and adjust interest rates accordingly to control inflation. In the current mortgage market, with interest rates regularly increasing, a significant decrease in inflation should offer a positive outcome for the mortgage and housing market in the future – however this is unlikely to be an immediate fix. Potential homebuyers and sellers can hope for more affordable borrowing costs and increased activity in the property market if inflation were to fall significantly. Understanding the dynamics between inflation and mortgage rates is vital for individuals navigating the housing market and making informed decisions about their mortgages.

As ever, at Fowler Smith Mortgages & Protection we'd be glad to answer any questions you have relating to your current/future mortgage and interest rates.

01206 635 550


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