UK inflation slowed to 2 per cent in May, falling to its lowest level since July 2021, according to new official figures.
It has matched the target inflation rate set by the Government and the 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 fall.
But experts said that, even as inflation returns to target, the Bank of England is still willing to hold off on any interest rate cuts (which could help ease mortgage rates) until after the general election. of the 4th of July.
The bank will announce interest rates on Thursday, but economists have already warned that the reduction may not come until autumn.
But what exactly is the relationship between inflation and interest rates, and how does it affect mortgage rates?
Inflation and interest rates
The Bank of England uses interest rates as a tool to help control inflation.
As of June 2024, rates are currently at 5.25%, having remained at the level for the last six votes by the Bank's policymakers.
They were raised to this level to make it more expensive for people and businesses to borrow money, weighing on their demand for goods.
This makes it difficult for companies to continue raising prices at the same rate, contributing to the slowdown in inflation.
Rate setters at the Bank look at the overall inflation rate, but also have an 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 generally higher than the Bank of England base rate, although some types of mortgages follow the movements of the Bank of England base rate.
Most people with a mortgage will be affected in some way by a change in interest rates. How exactly will depend on the type of mortgage, among a variety of other factors.
Discount, Tracker, and Standard Variable Rate (SVR) Mortgages
An SVR is set by the mortgage lender and generally follows movements in the Bank of England 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 are linked to the Bank of England base rate. Rates can increase more on a tracker mortgage compared to an SVR.
For example, a tracker mortgage could be set 1 percent above the base rate. In December 2021, this would mean the mortgage rate would be 1.1%. However, in June 2023, it would have increased to 6 percent.
Fixed rate mortgage
Fixed-rate mortgage rates will remain the same for the period of time agreed upon between the borrower and the lender, regardless of whether interest rates go up or down.
Once the fixed term ends, borrowers automatically move onto the mortgage lender's SVR, which is affected by Bank of England rates.
