The tug of war between the Bank of England’s monetary policy and government fiscal policy over what is driving up mortgage rates has intensified in recent years, making life more challenging for advisers and borrowers.
Swap rates — a key driver of fixed-rate mortgages — are influenced by expectations of future interest rates, which in turn depend on inflation, central bank policy and the wider economy.
When inflation is high and the central bank is expected to keep rates elevated for longer, or when global or political events increase costs and risk, swap rates tend to rise.
According to Nicholas Mendes, mortgage technical manager at John Charcol, gilt and swap yields usually carry more weight than the BoE’s base rate when lenders price fixed-rate mortgages.
“The base rate sets the tone, but it’s the movement in swap rates, which mirror gilt yields and wider expectations, that really drives lenders’ funding costs,” he says.
“Over the past couple of years, that balance has tilted further towards the gilt market as bouts of fiscal and bond market volatility have made funding less predictable.
“Right now, the high mortgage rate backdrop is as much about gilt yields as it is about bank rate. Fiscal signals and borrowing needs sway investor sentiment, nudging longer-term yields higher even when the BoE stands still.”
Government fiscal policy significantly impacts bond yields, as increased government spending or lower taxation, which leads to larger budget deficits, often results in higher bond issuance and potentially higher yields to attract investors.
And, if government finances are perceived as unstable, this can increase default risk and inflation fears, driving yields up further.
Fiscal policy, debt levels, and market sentiment all interact to influence borrowing costs.
Swaps, gilt yields and market sentiment
Lea Karasavvas, managing director of Prolific Mortgage Finance, says swap rates remain the main influence on lenders’ pricing. “This signals where markets expect to be over those durations,” he says.
“For example, the two and three-year swap markets both sit just under 3.5 per cent — their lowest since August 2022. With one-year swaps over 3.6 per cent, the market suggests a soft easing of rates over the next three years.
“With base rate currently at 4 per cent this has to be considered, but lender pricing is far more focused on swap rates and the gilt markets than the BoE’s base rate.”
David Hollingworth, associate director for communications at L&C Mortgages, agrees that financial market sentiment plays a significant role.
“Movement in market rates like swap rates can be a good indicator of the general direction of travel rather than predicting exact pricing,” he says. “If financial data shifts market expectations . . . that affects lenders’ funding costs and alters product pricing.
“The fact that changes in sentiment can move mortgage rates is why borrowers sometimes can face a sharp turnaround in rates even when there’s been no change in [the base] rate.”
Hollingworth adds that lenders’ appetite also plays a role. “Some lenders will be prepared to give up margin for additional volume, while others may prefer to keep more fat in the product. There may still be movement in line with the general trend, but by varying degrees.”
Fiscal-monetary tension
Robert Gardner, chief economist at Nationwide, says: “Shifts in swap rates are largely driven by changing expectations for the path of bank rate in response to developments such as data releases and policymakers’ statements. Fiscal policy is clearly important in this context as tightening or loosening can also impact the outlook for bank rate.”
The clearest example of this tug of war came with the 2022 “mini”-Budget, when fiscal shock undermined gilt confidence. Long-dated yields surged, swaps repriced sharply, and mortgage rates jumped — all before any BoE move.
Karasavvas recalls: “The ‘mini’-Budget was the most obvious [example] in recent years where the spike in swaps created a severe payment shock — the worst I have seen since being in the mortgage industry.”
Mendes points to other moments of tension:
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Pre/post fiscal statements (various 2023-25): Markets second-guessed borrowing paths ahead of Budgets/Autumn Statements; long-end gilt yields and five-year swaps nudged mortgage pricing even when the bank rate was unchanged.
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UK inflation surprises (mid-2023): Upside CPI prints revived concerns about the fiscal room for manoeuvre and term premia; gilts sold off, and lenders repriced despite no fresh BoE action that week.
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Post-Covid reopening (2021-22, global/UK): Big fiscal support and reopening demand met shrinking central bank purchases; term premia rose, gilts and global yields climbed, and fixed-rate mortgages moved up ahead of (and then alongside) policy hikes.
“Each of these moments highlights how gilt and swap markets can move independently of the BoE’s decisions, feeding directly through to mortgage pricing,” Mendes says.
“This push and pull makes planning harder. When markets react to both monetary and fiscal signals, the usual guideposts for rate direction become less reliable. We’ve had periods where data pointed to falling rates, yet gilt yields rose on fiscal or bond market jitters, catching lenders and borrowers off guard.
“It means advisers spend more time helping clients understand that timing the market is nearly impossible, and the focus has to shift to personal risk tolerance and flexibility rather than short-term rate calls.”
Karasavvas adds: “As brokers, we’re always asked where rates will be in two years. Having spent decades saying ‘no one has a crystal ball’, I now go further by explaining swap rates, their impact on pricing . . . and how they are our best steer to knowing where rates are expected to be over the fixed durations.”
Advisers’ role in a volatile market
Given rates’ reliance on sentiment, Hollingworth warns that borrowers should not become fixated on what might happen. “Advisers need to be clear that while the current trend may be up or down, sentiment can shift quickly,” he says.
Equally, even if the base rate falls, that may not automatically bring down mortgage rates.
As markets predict where rates may head, fixed rates have already priced in those cuts, so a drop in base rate may barely “cause a ripple”.
Signs of relief ahead
Mortgage rates are now expected to fall further. The most recent inflation figure of 3.8 per cent in September — below the BoE’s 4 per cent forecast, although far higher than the 2 per cent target — suggests a base rate cut could be near, with confidence feeding through to lower swap rates and lender pricing.
Karasavvas says: “The current higher rates reflected expectations that inflation would hit 4 per cent before year-end. This has now eased with the latest CPI print at 3.8 per cent, driving swaps down significantly in recent days.
“This has already prompted a barrage of mainstream lenders to cut rates swiftly, just after raising them pre-CPI announcement. Most lenders do not see further base rate hikes on the horizon, barring any macroeconomic shocks. The consensus points to base rate dropping to around 3.5 per cent next year, but all seem to be agreed on a reduced base rate in 2026 and a stronger mortgage market than 2025.”
Mendes notes that the BoE’s “higher for longer” message has kept a risk premium in longer-dated swaps, keeping five-year pricing sticky even as data softens.
But governor Andrew Bailey’s comments about the economy running below potential, and a weaker labour market point to cuts ahead, though the Monetary Policy Committee remains wary of stubborn services inflation.
“Looking ahead, the first real move is more likely to come from monetary than fiscal policy,” Mendes says. “If the BoE cuts in February, as markets now price, swap rates should ease further, and fixed mortgage pricing should follow. Fiscal pressures may linger if wage settlements and spending plans keep borrowing elevated.”
Karasavvas adds that in a falling rate environment, brokers must now more than ever track rates post-approval more closely. “By reviewing offers weekly, brokers can save clients thousands, sometimes tens of thousands . . . [failure to do so] could leave brokers at risk,” he warns.
“I believe brokers have actually realised the importance of swaps and pricing over the past few years. The rate volatility we’ve seen means brokers’ work continues much further into the process than it ever used to.”
The fiscal-monetary tension the industry has been experiencing is unlikely to ease soon.
Following the government’s spending review, the upcoming Budget is set to clarify the government’s borrowing needs.
Markets will be watching closely to gauge how bond issuance plans influence gilt yields and swap pricing.
Ima Jackson-Obot is deputy features editor of FT Adviser
