Could interest rates drop below 4% next year? Whilst there was only one base rate reduction during the whole of 2005, speculation has been rife throughout the year on the impact of the MPC’s decisions on the stability of the housing market. Ray Boulger, senior technical manager at John Charcol forecasts what we can expect to see in the New Year.

Base Rate in 2006

To achieve the desired impact on the economy, Base Rate nearly always needs more than one movement so we expect a number of cuts in 2006, argues Ray Boulger.

"The Bank of England has made it clear that they intend to alter the interest rate to influence inflation next year, despite house prices being targeted over the last few years. House prices are unlikely to move sufficiently in 2006 to overly concern the Bank and the below par growth in the UK economy will inhibit inflationary pressures," he said.

First cut in first quarter

Ray Boulger expects interest rates to drop by 0.75% in the next twelve months with the first snip coming by spring. "The major uncertainty on the inflation front is the price of volatile commodities, particularly oil," he said. "However, current indications are that inflation will fall from its current level (2.3% annual rate in October) to below the Bank’s target level of 2% by the third quarter of 2006. In anticipation of this we expect to see at least two, but probably three, base rate cuts in 2006, with the first 0.25% coming in the first quarter."

Property prices in 2006

"Some confidence returned to the market after August’s base rate cut," said Ray. "Transactions, in the second half of 2005, were well above the preceding six months as vendors, who had been holding out for higher prices, accepted lower offers. Interest rates are by far the most important influence on house prices and the cuts we expect in 2006 should stimulate a gentle upward movement in prices as confidence and affordability improves further."

"The ratio of house price to mortgage payments is far more relevant than the house price to earnings ratio favoured by many economists and by the former measure house prices are not expensive. Therefore they will rise at a steady level and we expect them to grow by approximately 5.5% by the end of 2006," he said.

What’s in store for mortgage borrowers?

First-time buyers - The recent decision by the government not to allow residential property into Sipps should mean good news for first time buyers. Much of the property that was being lined up for investor landlords may now make it into the hands of this beleaguered bunch. The government’s proposed shared equity schemes will enable a relatively small number to get onto the ladder when it starts in October. Although these plans are a starting point, expect to see more private schemes in the near future offering rent free shared equity mortgage deals.

2006 mortgage market - Boulger expects more lenders to follow Woolwich’s and Accord’s lead on retention by offering new business rates to existing customers while still allowing them to use a broker to source. "Failure to do this will result in a continued high proportion of customers defecting from their lender after their initial deal has finished, resulting in the lender paying a fee again and incurring more admin costs, simply to replace the lost business," he said.