Base Rates Drop, But Your Mortgage Won't: The Economics Behind the Paradox

If you’ve been keeping a close eye on interest rates lately, you might be scratching your head at a perplexing reality: even as the Bank of England cuts its base interest rate, mortgage costs have been sneaking upwards. It’s the kind of contradiction that makes you want to dig into the nearest economics textbook—or maybe just cry over your monthly payments. But what’s going on here? Why aren’t lower base rates translating to lower mortgages?

To understand this puzzle, we need to start with a little economic backdrop. The Bank of England’s base rate sets the tone for borrowing costs across the economy. A cut from 5.25% to 4.75% earlier this month was supposed to lower the cost of borrowing. But instead of resulting in cheaper mortgages, average rates on two-year and five-year fixed deals actually rose. Enter swap rates, which, despite sounding like an online barter marketplace, are the rates commercial banks and other lenders charge each other for exchanging fixed interest payments for variable ones. Lenders use these rates to price mortgages, and they’ve been on the rise thanks to a mix of domestic and global economic uncertainty.

Why the drama? Blame it partly on recent political moves, such as the government’s Budget, and the U.S. presidential election, both of which injected a dose of unpredictability into market outlooks. Add to that lingering worries about inflation, and you have a potent cocktail causing swap rates to rise—pushing lenders’ borrowing costs up, even as the base rate falls.

For borrowers, it’s a bitter pill to swallow. Nearly 800,000 fixed-rate mortgages with interest rates at 3% or lower are set to expire annually until 2027. The prospect of swapping these deals for new ones at 5% or higher is about as welcome as a surprise Economics mock exam. The outlook isn’t entirely bleak, however. While mortgages rates are moving up, they’re not soaring as they did in 2022 and 2023. The Bank of England has signalled that base rates will likely continue to fall—just not as quickly as some had hoped. We might reach base interest rates of 4% by the end of 2025. Which is good news for me as I am on a two-year variable rate mortgage!

Mortgage market quirks also come into play. With competition among lenders and a need to manage business volumes, even small changes in demand can lead to quick adjustments. As Aaron Strutt from Trinity Financial puts it, “Any standout best-buy deals are not lasting very long.” Like a game of financial Whac-A-Mole, as soon as one deal appears, it’s swiftly beaten back by market forces.

So, what’s the big takeaway? Borrowers should keep their eyes peeled and be prepared to act fast when good deals emerge. And remember, while the direction of interest rates matters, timing is everything—much like telling your economics teacher the dog ate your essay or your younger brother swiped everything off your laptop.

Glossary of Key Economics Terms:

• Base Rate: The interest rate set by the central bank that influences borrowing costs across the economy.
• Fixed-Rate Mortgage: A mortgage where the interest rate remains constant for a specified period.
• Inflation: The rate at which the general level of prices for goods and services is rising.
• Swap Rates: Rates used in financial markets that affect how lenders price mortgages; they reflect the cost of exchanging fixed interest payments for variable payments.
• Variable-Rate Mortgage: A mortgage where the interest rate can change, often in line with the base rate.
• Budget: Government’s financial plan, outlining its revenue and expenditure for a certain period.