Interest rates will fall to 2.5% by late 2027, a much sharper drop than the 3.75% market consensus, according to an influential economic research company.
Economists at Oxford Economics think the Bank of England will reduce interest rates at a greater rate than financial markets are currently forecasting.
The market forecast is that rates will fall to 3.75% by the end of 2025, and then settle at around that level and become the new normal.
But Oxford Economics believes the downward momentum will continue through 2026 and 2027, with rates settling at around 2.5%, owing in part to the fact that financial markets are anticipating higher inflation than they are, while demographic changes will also play a part.
Andrew Goodwin, chief UK economist at Oxford Economics, said: “Over the longer-term, the level of interest rates tends to be determined by structural factors, such as demographics and productivity growth.
“Before the pandemic, interest rates were very low largely because the population was ageing and productivity growth was very weak.
“Once the bout of high inflation has passed, we expect these structural factors to reassert themselves.
“The drag from demographics is likely to be similar over the coming decade to the pre-pandemic period, particularly given the state pension age is due to increase by only one year.
“And though we think developments like AI will provide some support, we think it’s unlikely that productivity growth will get back to the much stronger rates that the UK used to achieve prior to the global financial crisis.”
Oxford Economics’ latest projection is slightly higher than the fall to 2% in 2027 it was forecasting last year.
If its 2.5% forecast proves accurate, it could have significant implications for fixed rate mortgages.
However, Goodwin does not expect fixed rate mortgages to fall anytime soon.
“A lower Bank of England policy rate should eventually translate into lower mortgage rates for UK homeowners, but not just yet,” he said
“Financial markets think that bank rate will settle at a much higher level than Oxford Economics anticipates, and – if we’re right – markets are likely to take some time to come around to our way of thinking,” he added. “It’s likely to be a couple of years before mortgage rates drop back below 4%.”