Homeowners are facing another five years of mortgage pain as interest rates are expected to remain higher for longer.
The Office for Budget Responsibility now expects Bank of England central interest rates to settle at 4pc by the end of its forecast period in 2028-29, rather than fall to 3pc as it had assumed in March.
The Bank Rate is now at 5.25pc and is expected to peak a little above this by the end of this year, the spending official forecaster predicted.
The change is based on figures which suggest inflation will remain higher for longer than previously predicted, taking until the second quarter of 2025 to return to its 2pc target – more than a year later than previously forecast in March.
The OBR said it had previously assumed that the spike in inflation was mostly driven by a surge in global energy prices, but average pay growth of 8.5pc is now also playing a part.
It said around half of the impact of interest rate rises has yet to feed in through to the economy as many households have fixed-rate mortgages that have not yet reached renewal.
Mortgage rates on average are expected to rise from a low of 2pc in 2021 to a peak of 5pc in 2027 across all properties – 0.8 percentage points above the OBR’s forecast in March.
In four years rates are expected to be 2.2 percentage points above the average of the previous decade.
The OBR raised its mortgage forecast from 4.1pc to 4.9pc in January 2028.
For a homeowner with a typical £200,000 mortgage, this jump would represent an increase of £1,092 a year, or £91 a month, according to broker L&C.
Max Mosley, senior economist at the National Institute of Social and Economic Research, a research consultancy, said inflation was suffering from “second-round effects” as businesses pass on the costs of previous shocks such as high energy prices and disruptions to supply chains during the pandemic.
He said: “There is a bit of a circular flow here, which is that if prices go up, workers demand more money, and then they get more money, go out and spend it and then that might add to demand.”
Mr Mosley said he did not expect interest rates to come back to where they were over the last 10 years.
He said low interest rates were “reflective of austerity measures” and a “very cold fiscal policy”, adding: “The Government took a step back in investing in the economy, so things started to cool down, which then meant interest rates had to be rock bottom for quite a long time.
“That’s just one element of why that was the case, but that’s no longer the case today. The idea that interest rates are going to fall to that level again in the near term is unfortunately for the birds.”
David Hollingworth, of L&C, said many borrowers were coming to the end of current low rates and “facing quite severe payment shock”.
He said: “Interest rates are not going to be dropping back to those ultra-low levels that people became so used to after the financial crisis and into the pandemic period.
“That went on for so long that understandably borrowers became used to that being the norm. This has snapped us back into what is more like a long term outlook for interest rates.”
While mortgage rates have been coming down on the back of better-than-expected inflation data, he said borrowers still needed to “readjust to the new landscape”.
