Interest charges might be 2.5% by late 2027, economist predicts: What would that imply for mortgages?

An influential economic research firm predicts interest rates will fall to 2.5 per cent by late 2027, a much bigger drop than the 3.75 per cent market consensus. 

Economists at Oxford Economics think the Bank of England will cut interest rates far further than financial markets are currently forecasting.

The market forecast is that rates will fall to 3.75 per cent by the end of 2025, and then settle at around that level and become the new normal.

However, Oxford Economics believes the downward momentum will continue through 2026 and 2027, with rates settling at around 2.5 per cent. 

Andrew Goodwin, chief UK economist at Oxford Economics says the difference is partly because financial markets are anticipating higher inflation than they are, but also partly because of demographic changes.

‘Over the longer-term, the level of interest rates tends to be determined by structural factors, such as demographics and productivity growth,’ says Goodwin. 

‘Before the pandemic, interest rates were very low largely because the population was ageing and productivity growth was very weak.

‘Once the bout of high inflation has passed, we expect these structural factors to reassert themselves. 

‘The drag from demographics is likely to be similar over the coming decade to the pre-pandemic period, particularly given the state pension age is due to increase by only one year. 

‘And though we think developments like AI will provide some support, we think it’s unlikely that productivity growth will get back to the much stronger rates that the UK used to achieve prior to the global financial crisis.’

Oxford Economics’ latest projection is slightly more cautious than what it was forecasting last year. Only a few months ago, it was suggesting interest rates would eventually fall to 2 per cent in 2027.

It says the recent change to the UK’s fiscal rules in Labour’s October Budget suggests policy will be looser in future. 

It also expects the new US policy landscape will mean higher, more volatile inflation across the world, which will place a little more upward pressure on rates.

What would this mean for mortgage rates?

If Oxford Economics’ forecast proves to be right and rates do hit 2.5 per cent by the end of 2027, what would happen to mortgage costs? 

Fixed mortgage rates are determined by swap rates, rather than the central bank’s base rate.

Swap rates reflect the market’s expectations of future interest rates and play a critical role in how lenders price fixed mortgage products. 

At present, fixed rate mortgages have priced in future interest rate falls, but nothing like the extent being forecast by Oxford Economics. 

If its 2.5 per cent forecast proves accurate, it could have significant implications for fixed rate mortgages, according to Nicholas Mendes, mortgage technical manager at broker John Charcol. 

‘Fixed mortgage rates are typically priced with a margin above swap rates, reflecting lender costs, risk considerations, and profit,’ he says.

‘If swap rates align with a 2.5 per cent base rate environment, fixed mortgage rates would likely fall below 3 per cent. 

‘However, individual circumstances, broader market conditions, and lender policies will all influence the exact rates available.’

Mendes thinks lender appetite will also play a significant role in determining where fixed mortgage rates are priced going forward.

‘As the market stabilises, consumer confidence typically returns, helping to bolster property prices,’ adds Mendes. 

‘In a more stable market, lenders’ attitudes to pricing may shift compared to the trends observed over the past two years. 

‘During this period, the market has been challenging, with lenders aggressively competing for business in a stagnant environment characterised by lower levels of mortgage applications.

‘In the future, while lenders will still seek to attract borrowers, the extent to which they are willing to compress margins may change. 

‘It will be interesting to see how lenders balance their appetite to win business with maintaining margins in a more stable environment in the future.’

However, Andrew Goodwin of Oxford Economics thinks fixed rate mortgages won’t be falling any time soon.

‘A lower Bank of England policy rate should eventually translate into lower mortgage rates for UK homeowners, but not just yet,’ says Goodwin.

‘Financial markets think that bank rate will settle at a much higher level than Oxford Economics anticipates, and – if we’re right – markets are likely to take some time to come around to our way of thinking. 

‘It’s likely to be a couple of years before mortgage rates drop back below 4 per cent.’