Why mortgage and savings rates are falling when they should be rising

         Savings and mortgage rates have fallen despite a rise in the wholesale cost of borrowing. But some fixed rates could soon rise. The rates at which banks and other financial institutions lend to each other has risen sharply but in a break with historic patterns, there has been no beneficial knock-on effect for savers. Signs of improvement in the economy means "swap” rates, which measure the cost of raising money on the capital markets, have almost doubled since April, rising gradually through May and then soaring in recent days. The swap rates on two-year money have risen from 0.55 per cent in early March to 0.97 per cent today. On five-year money rates have rocketed similarly from 0.99 per cent to 1.8 per cent.

         These institutional rates were historically closely linked to households’ personal finances: as swaps went up or down, the fixed rate deals on offer on mortgage and savings tended to follow.

But since the financial crisis that link has been broken, with commentators blaming the flood of cheap money being made available to lenders through the Government’s Funding for Lending Scheme. The scheme’s intention was to provide banks with cheap finance to stimulate lending to businesses and households - but one cruel consequence has been to depress rates paid to savers. This is because with the Government’s cheap cash at hand, lenders do not need to attract private savers’ deposits.

         So savings rates have continued to drop during a period when comparable swaps have risen. The best available two-year savings rate in March paid 2.45 per cent, according to Savingschampion.co.uk - in June that has fallen to nearer 2.3 per cent. And five-year best-buy rates, which exceeded three per cent in March, are now huddled around 2.75 per cent.

There is no indication that fixed deposit rates will improve, according to Savings champion's Anna Bowes. She said: “The Funding for Lending Scheme is having a stronger effect than swap rates. It is continuing to devastate returns for depositors, and I can’t see that stopping.”

The outlook is different for mortgage borrowers, however - where there are early signs of fixed rates being tickled upwards in response to the rise in the cost of interbank lending. Mortgage broker London & Country in Bath reports a number of recent fixed rate increases, including a recent rise by Skipton Building Society of its five-year rate from 2.88 per cent to 3.19 per cent. Newcastle Building Society increased one of its five-year fixed rates from 3.59 per cent to 3.99 per cent.

        Other smaller lenders have withdrawn some fixed rates - presumably with the intention of repricing them. London & Country’s David Hollingworth said: “Swap rates have been rising gradually for some time but have recently increased very sharply. Five year swap rates have been particularly affected and are now double the level of early May. This will undoubtedly put upward pressure on lenders’ fixed rates. "Although the improved competition market has seen rounds of rate cuts in recent months that trend looks set to halt and even reverse.” His advice to borrowers who can and want to switch to a fixed rate is to do so quickly.

         Jonathan Harris, director at London-based mortgage broker Anderson Harris, said: “Despite the significant jump in swap rates it is important to remember that lenders are not relying wholly on the money markets for funding. "Many are now accessing Funding for Lending cash and so rising swaps shouldn’t affect this. The economy is still weak and we don’t expect interest rates to rise in the near future - but borrowers looking for a fixed rate might want to consider moving sooner rather than later.”

         Other experts believe that banks will be keen to lend more, which could help keep rates down. Mark Harris, chief executive of mortgage broker SPF Private Clients, said: "Rates are very competitive and while we acknowledge that swap rates have risen, a number of lenders are behind on lending volumes and are keen to lend more in the second half of the year." Mervyn King used his final public speech on Tuesday to warn that over-extended borrowers, mainly those in their thirties and forties, could struggle if interest rates returned quickly to normal levels.

He said some households would find increased mortgage costs “unsustainable” but added: “The idea we are about to return to normal levels of interest rates is premature, precisely because so many households have such a high level of debt.”