Bond Market versus BoE Base Rate

stueyhants

Most posters bullish or bearish accept that demand and supply of credit is going to tighten over the next few years (removal of SLS as one example and extra government guilt issuance is the other main factor). This is likely to place upwards pressure on rates, by how much or little is anyone’s guess, but the direction I would argue is generally accepted.

These rate increases will cause a gradual increase in SVRs and new mortgage rates (either through higher fixes or greater spreads on BoE base rate). Competition in the market may absorb some of these increases, so I'm not arguing that SVR rates are going to shoot to the moon or anything, just a steady trickle up.


Give that, does the BoE have to change base rate to mirror the ‘real’ money market rates? Can the disconnect between Base rates and LIBOR (1,5,10 year … etc) grow wider, are there any consequences ?

Base rates are used control inflation, but given the current economic problems and likely tax increases I would argue inflation could be controlled using tax and spending rather than IR, thus the pressure to raise official base rates is going to be low.This will help current homeowners but will not prevent rates for new borrowers going up ?


Does this argument hold water, or is it just my new bullish perspective due to bagging a 1.99% over base lifetime tracker rate

HammerSmashedFace

I've always said that the reckless encouragement of people to borrow large sums of money on an asset that is over-valued for 25 years when rates are low will end in disaster.

Low rates are helping people who have already borrowed and have a mortgage, but if you are a new borrower you should be factoring in 8%+ rates, inflation in wages is going to be non existent over the next few years, so those rate increases should be factored against salaries that are being earned today.

Cleaver

HammerSmashedFace wrote: »

I've always said that the reckless encouragement of people to borrow large sums of money on an asset that is over-valued for 25 years when rates are low will end in disaster.

Low rates are helping people who have already borrowed and have a mortgage, but if you are a new borrower you should be factoring in 8%+ rates, inflation in wages is going to be non existent over the next few years, so those rate increases should be factored against salaries that are being earned today.

A young couple buy a house now and get a mortagage with a low interest rate. The worst case scenario is that they buy a house now, then over 25 years they never get a different job and rates rise to 8% for years. Is this really likely? Or will there be a variety of interest rates over the next 25 years based on the economic climate of the time? And will the people remain on the same salary for 25 years? I doubt it. They'll get promotions, new jobs, maybe get made redundant, maybe get some inheritance, probably have kids and have to cope on one income for a while, maybe do really well in their career and earn a lot of money... there's so many variables. It's always been like this and people cope.

Of all the people I know there is a very, very small number who get one job and stay in it for years and years. Most people, probably motivated deep down by boredom, tend to work their way up in to better jobs: some at a quick pace, some more steadily.

Why do you always base future outcomes on the complete worst case scenario? What you've described above will happen for some of the unfortunate few who aren't financially savy or fall on hard times, but the majority will probably be okay, rather than it all 'ending in disaster'.

HAMISH_MCTAVISH

stueyhants wrote: »

Base rates are used control inflation, but given the current economic problems and likely tax increases I would argue inflation could be controlled using tax and spending rather than IR, thus the pressure to raise official base rates is going to be low.This will help current homeowners but will not prevent rates for new borrowers going up ?

Spot on. This is what many of us have been arguing for a long time now.

Fiscal tightening will create enough drag on the economy to ensure base rates will stay low. Existing mortgages will therefore stay low.

So no rate induced crash on the horizon any time soon.

Does this argument hold water, or is it just my new bullish perspective due to bagging a 1.99% over base lifetime tracker rate

:rotfl:

Thats my SVR rate. Capped at BOEBR + 2%.

Can't believe borrowers now think thats a good deal.....:eek:

Jonbvn

Cleaver wrote: »

Of all the people I know there is a very, very small number who get one job and stay in it for years and years.

This is very true. The whole "job for life" ideal is history. Even in Japan the "salarymen" are a dying breed.

stueyhants

But what happens when the spread between base rates and new mortgage rates get stupidly big. Currrently five year fix spread is around 4.5%, what happens if that goes up to 5,6,7 and so on. Does anything happen ?

Future investors will be lending money at the new higher rates so they will carry on lending. I suppose the big losers are those who have a large number of customers on low BoE rates but unable to refinance loans at the same rates (i.e building soceities).

StevieJ

stueyhants wrote: »

Most posters bullish or bearish accept that demand and supply of credit is going to tighten over the next few years

You mean tighten from a credit crunch :eek:

stueyhants

StevieJ wrote: »

You mean tighten from a credit crunch :eek:

Or go back to normal following a credit binge :rotfl:

globalds

Cleaver wrote: »

Why do you always base future outcomes on the complete worst case scenario? What you've described above will happen for some of the unfortunate few who aren't financially savy or fall on hard times, but the majority will probably be okay, rather than it all 'ending in disaster'.

That is generally considered the right way to do it.

If you were planning a long journey the last thing you would want to hear as you cast off your moorings would be the shout from shore " As long as you don't get any rough sea you will be fine".

As the old saying goes ...Plan for the worst , Hope for the best.

Generali

stueyhants wrote: »

Give that, does the BoE have to change base rate to mirror the ‘real’ money market rates? Can the disconnect between Base rates and LIBOR (1,5,10 year … etc) grow wider, are there any consequences ?

The base rate (AIUI) is what used to be called the Repo Rate.

A Repo is a kind of transaction between banks when one bank lends another money secured against Gilts. For example, Stueyhants Bank might want to borrow £1,000,000 from Generali Bank. Stueyhants Bank delivers £1,000,000 worth of bonds and Generali Bank lends £1,000,000 to Stueyhants Bank for an agreed period (say a week or a month) and charges a rate of interest. When Stueyhants Bank repays the money, it gets the Gilts back. If it defaults, Generali Bank can sell the Gilts to get its money back.

Now the BoE will enter into Repos with banks in the UK and the rate of interest it uses is the Base Rate I believe. Now take an example where the base rate is 0.5% but 1 year Gilt yields are 2%. Stueyhants Bank can buy £1,000,000-worth of Gilts and then enter into a 1 year repo with the BoE* so Stueyhants Bank ends up having its million quid still which it can use to do something profitable.

At the end of the year, Stueyhants Bank repays the debt + interest which is £1,005,000 and gets its Gilts back. At this point, the Gilts mature and Stueyhants Bank gets £1,000,000 as principal sum back plus £20,000 in interest, a £15,000 guaranteed profit. Clearly, that isn't a trade that can be allowed to continue for long unless you're printing the money to pay the banks.

So now you should think about what follow-up question you want to ask about QE.








*I know IM and others, a 1 year repo with the BoE is unlikely but this is an example so I'm trying to keep it simple.

StevieJ

Generali wrote: »

The base rate (AIUI) is what used to be called the Repo Rate.

A Repo is a kind of transaction between banks when one bank lends another money secured against Gilts. For example, Stueyhants Bank might want to borrow £1,000,000 from Generali Bank. Stueyhants Bank delivers £1,000,000 worth of bonds and Generali Bank lends £1,000,000 to Stueyhants Bank for an agreed period (say a week or a month) and charges a rate of interest. When Stueyhants Bank repays the money, it gets the Gilts back. If it defaults, Generali Bank can sell the Gilts to get its money back.

Ahh, like a !!!!!! or was that pawn shop, you know the one with the hanging balls they certainly seem to be making a comeback.