Financial Times FT.com

Homebuyers face higher mortgage rates

By David Oakley, Capital Markets Correspondent

Published: May 29 2009 02:31 | Last updated: May 29 2009 02:31

Banks are likely to face increasing pressure to put up fixed mortgage rates after a sell-off in the government bond markets this week.

Analysts warn that the sharp rise in government bond yields, which have an inverse relationship with prices, will lead to higher mortgage rates on the high street.

Government bond yields on five-year gilts rose to 2.61 per cent on Thursday – the highest level since February 26. Yields have risen from lows of 2.0 per cent since the start of March.

The rise in yields forces banks and building societies to raise fixed rate mortgages as these are calculated by using swap rates, which tend to move in line with government bond yields.

A swap rate measures the cost for a bank or building society to swap or switch from a floating rate to a fixed rate. Swap rates fixed over five years rose to 3.3 per cent on Thursday from lows around 3 per cent at the start of March. Swap rates maturing over five years are typically used to calculate mortgages. Many analysts forecast government bond yields and swap rates will continue rising this year.

John Wraith, head of sterling rates product development at RBC Capital Markets, said: “Government bond yields and fixed mortgage rates are still relatively close to historic lows, but any material rise in government funding costs will have a knock-on effect on secured borrowing, putting significant pressure on households.

“This could have a serious impact on any economic recovery in the UK. The recent improvement in sentiment could easily go into reverse. It is too early to assume that the worst is over.”

Gilts were sold off because of renewed worries over the vast amount of debt the government is taking on to stimulate the economy. This was reflected in a poor government bond auction on Thursday as investors refused to take part because of worries over the £225bn ($359bn) in planned gilts sales this year.

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