Higher rate cloud has a silver lining

Interest rates are rising throughout the world and will probably hit 6% here by the end of 2007. This is bad news for clients on fixed rates but will eventually help first-time buyers, says Frank Eve

There’s been a great deal of change in the global financial markets recently and these fundamental shifts will affect the UK mortgage market.

The big news is that returns on 10-year US government bonds broke through the 5.25% mark for the first time in five years. US interest rates are at 5.25%, so if 10-year bonds are trading at the same price it looks unlikely that short-term in-terest rates will come down any time soon. Rates are also on the increase across Europe and in New Zealand they recently hit 8%.

At home, the money markets expect interest rates of 6% before the end of the year, suggesting that the era of low interest rates for British borrowers may be at an end, for the time being at least.

The reason for this shift is connected to the global economy working not badly but too well. China, Japan and India are its main drivers and business in these powerhouses is booming.

And despite the sub-prime problems in the US, the world’s biggest consumers are still in purchase mode. There are also signs of global inflationary pressures but, perhaps most importantly, China has started to sell its US government bonds to invest in equities.

In the UK we have become blas矡bout low interest rates. They hit a low of 3.5% in July 2003, which encouraged higher levels of consumer indebtedness.

Many pundits suggest that the lack of available property and consistently high demand have fuelled rising house prices. But I believe they have more to do with the increase in borrowing power that low interest rates afforded, together with the easy availability of credit. My theory will be tested when the effect of higher interest rates kicks in.

So what does this mean for mortgages in the UK? Banks and building societies will find their long-term funding costs increase and this will lead to the disappearance of many of the competitive fixed rate deals we see today.

When fixed rate borrowers come to the end of their existing deals and look for something similar, they’re going to be in for a shock. This could lead to higher levels of arr-ears and repossessions towards the end of 2008. In turn, house price growth should slow and this will impact on volumes.

But every financial cloud has a silver lining. Even at 6%, interest rates will still be low by historical standards and growing arrears will lead to more sub-prime remortgage business.

The global and domestic economies are in robust shape, so we should still see a strong housing market, particularly in London.

And lower volumes and flatter house price inflation could be just the combination needed to bring more first-time buyers back to the market.