Mortgage rates in biggest fall for over a year despite inflation shock

Mortgage rates have fallen at the fastest pace for over a year as investors bet the Bank of England will leave borrowing costs unchanged next week despite the inflation shock from the Iran war.

In a boost for millions of borrowers, the average two-year fixed rate fell from 5.87 per cent to 5.83 per cent on Wednesday while a typical five-year deal dipped from 5.76 per cent to 5.73 per cent.

Although rates are still sharply higher than before the Middle East conflict broke out at the end of February, one-day falls of this scale have not been seen for some time.

The drop in the five-year fix was the biggest since February last year while the two-year has not declined so sharply since August 2024.

The figures, from Moneyfacts, fuelled hopes that the cost of home loans may have peaked, though experts warned ‘recent volatility is a reminder of how quickly it can all shift again’.

Mortgage rates soared after the outbreak of war but may now have peaked

Mortgage rates shot higher after the US and Israel launched airstrikes on Iran eight weeks ago as soaring energy prices set the scene for a fresh inflation shock.

Inflation fears triggered bets that the Bank of England would raise interest rates as many as four times this year, taking them from the current rate of 3.75 per cent to 4.75 per cent.

Official figures today showed inflation jumped to 3.3 per cent last month following the biggest rise in fuel prices since the invasion of Ukraine by Russia sparked the last energy crisis.

But investors have dramatically scaled back bets on rate hikes amid hopes of a peace deal with financial markets suggesting a less than one-in-ten chance of such a move when the Bank’s monetary policy committee (MPC) meets next week.

However, there is still a nine-in-ten chance of a rate hike to 4 per cent by the end of the year as the Bank, led by governor Andrew Bailey, seeks to keep a lid on prices.

Adam French, head of consumer finance at Moneyfacts, said: ‘Mortgage pricing may have peaked for now. However, recent volatility is a reminder of how quickly it can all shift again.

‘The Bank of England itself now faces a delicate balancing act: act too slowly and inflation could become entrenched; act too quickly and it risks unnecessarily squeezing households already under pressure.’

James Smith, an economist at banking group ING, warned the Bank is ‘flying blind’ on inflation given uncertainty over how long the war will continue and its impact on energy prices and economy.

‘The latest rise tells us virtually nothing about the scale and duration of the inflation wave to come,’ he said.

Ruth Gregory, an economist Capital Economics, said the coming months ‘will be an uncomfortable ride’ for the Bank with inflation set to rise to around 4 per cent – twice the 2 per cent target.

But both she and Smith said they expect interest rates to be held at 3.75 per cent this year.

With Britain facing a painful bout of ‘stagflation’ – a toxic combination of sharply rising prices and weak-to-no economic growth – it is feared higher interest rates could push the economy into recession.

Bank of England Governor Andrew Bailey faces an ‘uncomfortable ride’ as inflation soars

Suren Thiru, chief economist at the ICAEW accountancy group, said: ‘This disheartening resurgence in inflation confirms stagflation fears.

‘The extended ceasefire won’t prevent a painful period of accelerating inflation with skyrocketing energy costs and food prices likely to lift the headline rate above 4 per cent by the autumn despite slower economic demand.

‘While these figures will make for uncomfortable reading, the looming downward pressure on prices from a weakening economy should give rate-setters enough latitude to look through this period of intensifying inflation and keep rates on hold.’

Danni Hewson, head of financial analysis at AJ Bell, said: ‘For the Bank of England, the spectre of stagflation will stalk MPC members as they sit around the table next week and try to keep their balance. 

‘If they don’t hike rates and inflation becomes embedded they will be accused of not acting soon enough, but if the UK does more than flirt with recession in the second half of the year they will face criticism for not doing enough to stimulate an economy struggling to remain steady.’

While mortgage rates have eased in recent days, the average two-year fix is still up from 4.83 per cent at the start of March while the typical five-year has risen from 4.95 per cent.