Energy price cap - impact on inflation & interest rates

MoneySavingDummy

It's now looking likely that the government will be freezing the energy price cap or otherwise intervening in energy prices. If so, I wonder if this will have a bigger impact on curbing inflation than raising interest rates ever could.

Does this mean that future interest rate rises will now be lower than previously feared? Are we now in the position where we are not only trying to predict future interest rates but also now need to 2nd guess any government intervention?

Up until today, I was thinking that fixing for 10 years was the best course of action, but now I'm not so sure.

jj_43

Its a very good question. The latest yield curve is 0.25% higher than last week, so the markets view is still trending higher.
Certainly freezing the energy price cap at current April levels would mean its impact on the calculation on inflation would be less  and inflation would be less high. However we don't know the secondary effects.

In this situation the main tell will be the strength of the £. We no longer focus on this, but as the situation becomes more dire and the economy is reverting to the 1970s/80s the level of the £ will matter. Already we are importing inflation due to the drop in £ and this has yet to be reflected in the inflation.

The BOE has issued forward guidance (simply scaring people) to reduce demand so that they don't need to increase interest rates as much. However they are still playing catchup in my view. And given further government stimulus means the BOE still needs to offset the inflationary effects of any untargeted handouts (tax decreases). So the government and BOE are having to work against each other at the moment. End result interest rates will be higher.

You state "Are we now in the position where we are not only trying to predict future interest rates but also now need to 2nd guess any government intervention?" yes, exactly, remember forward interest rates already reflect the current expected situation.

Fixing for 10 years, depends what you mean best course of action? certainly its not the best course of action if you want to minimise your mortgage interest costs.

LoomThought

Energy Price Cap and eventual government support will increase the discretionary expenditure and will be inflationary. Plus the need to prop up the £ so in my not so educated nor professional view the pressure to increase interest rates is higher now. At least they will stay high longer.

MoneySavingDummy

It looks like I have probably oversimplified the situation, assuming that the BoE wouldn't need to increase interest rates as high if there were other forces (energy freeze) helping to bring inflation down towards their 2% target.

I had glossed over the fact that the £ is at risk of being devalued further, as you have helpfully pointed out. So perhaps this is more of a driving force behind interest rates than inflation in the current circumstances?

The more I try to understand how interest rates may change in the future, the more I come to realise that I really have no idea. Although I tend to believe that the "market forecast", as indicated by swap rates, is probably as good a guess as any.

It feels like government intervention is just making the future even more uncertain. If they are willing to manipulate the energy market, who's to say they won't start bailing people out when they can't afford high mortgage rates? Or perhaps an energy cap freeze leaves more room for interest rates to be raised before mortgages become unaffordable (is this the gov's plan?).

So as you can see, I have lots more questions than answers. Ultimately I think I'm coming to the view that the risk of mortgage rates, and my payments, increasing to an unaffordable level is a much greater risk than me potentially overpaying if interest rates happen to remain lower than currently forecast. To my mind a mortgage rate of around 4% is still relatively cheap borrowing.

My mortgage is in 2 roughly equal parts, one fix ends this year and the other next year. Ideally, I would pay the ERC on the 2nd (about £1200) and then just fix both for 10 years. Unfortunately I'm currently disputing a default on my credit report, so I can't do that right now. Given it may take 4-8 weeks to resolve, I think the best I can do right now is just switch the 1st half to a 5y fix with my existing provider (no credit check) and then deal with the 2nd half next year at the end of the term. At least that way I have hedged my position - higher future rates would make the 1st fix look better, whereas lower future rates would benefit the 2nd part.

london21

Certainty is good but for me 5 years fix is good enough.

In the short term rates will go up but hard to predict tte next 2-5 years.