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UK inflation slowed to 2 per cent in May, dropping to its lowest level since July 2021, according to new official figures.
It has matched the target rate of inflation set by the Government and Bank of England after a slowdown in price rises over the past two years.
Chancellor Jeremy Hunt said he hopes the Bank of England will now cut interest rates so mortgage costs can come down.
But experts said, despite inflation returning to target, the Bank of England is still set to hold fire on any interest rate cuts – which could help to ease mortgage rates – until after the General Election on 4 July.
The bank will announce interest rates on Thursday, but economists have already warned that a reduction may not come until the autumn.
But what exactly is the relationship between inflation and interest rates, and how does it affect mortgage rates?
Inflation and interest rates
Interest rates are used by the Bank of England as a tool to help control inflation.
As of June 2024, rates are currently at 5.25%, having been held at the level for the past six votes by the Bank’s policymakers.
They were increased to this level to make it more expensive for people and businesses to borrow money, therefore weighing on their demand for goods.
This makes it hard for companies to keep increasing prices at the same rate, helping to contribute to the slowdown in inflation.
Rate-setters at the Bank look at the overall rate of inflation but also have a firm eye on specific areas, such as services inflation, which has been particularly sticky at 5.7% in May.
Interest rates and mortgages
Mortgage rates are agreed with individual borrowers and lenders, and are usually higher than the Bank of England’s base rate, though some types of mortgages follow movements in the Bank of England’s base rate.
Most people with a mortgage will be affected by a change in interest rates in some way. How exactly will depend on the type of mortgage, among a range of other factors.
Discounted, tracker and Standard Variable Rate (SVR) mortgages
A SVR is set by the mortgage lender and usually follows movements in the Bank of England’s base interest rate.
When interest rates rise, lenders are likely to pass this on to customers.
Tracker mortgages are another type of variable rate mortgage, but they’re linked to the Bank of England base rate. Rates may rise more on a tracker mortgage compared to an SVR.
For example, a tracker mortgage could be set 1 per cent above the base rate. In December 2021, this would mean a mortgage rate would be 1.1%. However, in June 2023, it would have risen to 6 per cent.
Fixed-rate mortgage
Mortgage rates on a fixed-rate will remain the same for the agreed period of time between borrower and lender, regardless of whether interest rates rise or fall.
Once the fixed term ends, borrowers are automatically moved to the mortgage lender’s SVR, which is affected by the Bank of England’s rates.
Source: independent.co.uk
