Predicting rates is a dangerous game

As central banks around the world edge interest rates upwards and concern builds that the US Federal Reserve will follow suit, the consensus of opinion is that UK interest rates will finish the year higher than they are now.

This message has been given extra weight by the governor of the Bank of England’s recent speech in which he said that the economy could be approaching “a somewhat bumpier stretch of road” following the period of strong growth it has enjoyed in recent years.

The Council of Mortgage Lenders’ revised forecasts for 2006 reflect a similar outlook. The organisation has revised its forecast of where the base rate will be at the end of the year up to 4.75% from 4.50%.

But it isn’t all bad news from the CML as it has increased its forecast for gross lending in 2006 upward from 285bn to 310bn after strong activity in the housing market in the first half of the year. As a result, the annual rate of house price inflation has increased to 7% from 2%.

Of course, widespread expectations of a rate rise will have an effect on the market in the second half of the year and while World Cup fever has had no appreciable impact on our business levels so far, it can’t be ruled out as a contributor to a slowing market over the next month, particularly if the England team progresses.

Rising interest rates – or even the threat of a rise – hits confidence which in turn leads to a downturn in housing market activity.

All the economists’ musings make perfect sense but it is important to remember that the general forecast for the base rate a few months ago was that it would be cut during 2006. This is not a precise science and rate predictions can change rapidly.

As fixed rates act in a predictive manner, rises have already been factored in and this has led to comments that trackers and discounted rates look better value than fixed rates. This makes the assumption that fixes have overshot where rates are likely to head rather than looking at the real reasons for taking up fixed rates. If borrowers are looking for certainty in their mortgage payments, fixed or capped deals remain the product types that can deliver.

It may be the case that a variable deal works out cheaper but this only goes to show that when even economists are altering short-term rate forecasts, nobody really knows what’s going to happen. It is a dangerous game for brokers to play to start acting as forecasters of rate movements rather than helping clients reach informed decisions.

After all, as an eminent economist once said: “There are two classes of forecasters – those who don’t know and those who don’t know they don’t know”.