There is mixed news on the economic front. Inflation largely appears to have been tamed. Yet the sheer scale of cost of living increases in past years has left adverse consequences for the economy and for households.
In inflation-adjusted terms, the average worker still earns less than just before the global financial crisis of 2008. The rise in incomes since 2022 has eased some of this pain, and pressures on household budgets should continue to weaken in 2025. But there are concerns that economic growth will continue to be feeble and that unemployment will rise as businesses cut costs rather than raising the prices of goods and services.
Meanwhile, the government is still paying the bill for the stimulus measures taken during the pandemic. The impact of Brexit has also yet to fully unravel. The UK needs productivity gains, but from where will they come?
The tough reality is that the economy remains fragile. It would not take much for inflation to accelerate beyond the Bank of England’s forecast of 2.5% by the end of 2025. If this happens, the Bank’s Monetary Policy Committee will be compelled to leave rates higher for longer. This outcome, which would force up mortgage rates, represents the single biggest risk to the housing market.
Based on the current outlook, we expect the base rate to fall to around 3.75% by the end of 2025, following four 0.25 percentage point cuts. These have already been priced into the cost of mortgage deals, making it unlikely that still-cheaper offers will emerge.
In the longer-term, the base rate is expected to settle at about 3.5% in 2026. But if an economic rebound does not materialise, there’s an argument that a lower rate of around 3% would be more appropriate.
"The base rate is expected to settle at about 3.5% in 2026. But if an economic rebound does not materialise, there's an argument that a lower rate of around 3% would be more appropriate."
At present, mortgages with a rate of just under 4% are available, but only borrowers with larger amounts of equity in their homes can apply. A high fee may also be attached, particularly if the applicant is a landlord.
By contrast, average mortgage rates still stand at around 5%. This suggests that there is scope for reduction next year in the cost of higher loan-to-value (LTV), high-income-multiple and buy-to-let offers. This should boost the prospects of first-time buyers (FTBs) and second-steppers.
We also expect to see the rate differential between two and five-year fixed rate deals narrow as mortgage rates near their new normal. Once the base rate settles at this level, mortgage rates may begin to become more expensive towards the end of 2026.
"Once the base rate settles, mortgage rates may begin to become more expensive towards the end of 2026."
This is because the yield curve is likely to return to its usual upward path, rewarding investors who are locking away money for longer. At the same time, there should be downward pressure on the cost of deals from lenders competing for a slice of a smaller pie.
On the political front, critics of the new government are focusing on the absence of good news and optimism. Sluggish economic growth and rising bills for servicing the national debt are curbing Labour’s capacity to bring about growth.
But, in the main, the government’s measures have been targeted at small groups. The winter fuel allowance reforms have affected pensioners, while the Budget measures on capital gains tax and inheritance tax have hit the more affluent. These tax rises will affect sentiment in the prime markets.
However, it's the fiscal drag from freezing income tax bands that will hurt. But the government seems to be opting to take tough decisions at the start of its term in office. Towards the end of this time, future rate cuts could enable some loosening of spending and taxes could start to fall.