Mortgage rate cuts need not squeeze bank profit margins

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UK banks were lambasted last year for failing to pass on interest rate rises to savers. Now that the Bank of England rate cycle appears to have peaked they seem to be making amends by engaging in a mortgage rate price battle. In theory, such largesse means profit margins will be squeezed. But lower funding costs could make up the difference.

This week, both HSBC and Lloyds Bank-owned Halifax cut remortgage rates by as much as one percentage point. Average two- and five-year UK mortgage rates exceed 5 per cent but competitive new products are being priced at 4 per cent or below. Mortgage rates are being reduced in line with falling UK bond yields, swap rates and the expectation of policy rates cuts by the end of this year.

For banks, intense mortgage competition can be expensive. Tightening mortgage spreads contributed to disappointing net interest margins at NatWest and Barclays last year. Typical spreads of 50 to 60 basis points at the end of last year barely covered costs.

The UK housing market has weathered the rate hiking storm far better than some forecasts expected. Still, activity slowed, prices dipped and approvals for new mortgages fell by about a quarter last year.

Volumes are now expected to rise. About 1.5mn fixed-rate mortgage deals are set to expire this year. Greater competition in the mortgage market will be helpful to borrowers. Arrears and possessions are already at historically low levels. This benign situation is expected to continue.

But even for banks, lower mortgage rates do not necessarily mean profit pain. Two and five swap rates used to price mortgages have fallen sharply in recent months and are down almost 150 basis points since the summer. Eye-catching reductions in mortgage rate repricings are not as generous. Falling rates will not automatically put extra pressure on NIMs.