Fixed income
How does falling inflation impact UK mortgage-backed securities?
2 min read 2 Aug 23
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UK inflation has fallen below market expectations for the first time since February this year, but what might this mean for UK residential mortgage-backed securities? We explain in charts.
The UK CPI has recently come in below market expectations for the first time since February. The market’s response was very bullish, with pricing reflecting fewer rate hikes being required to control inflation. This led to expected UK terminal interest rates falling from 6.5% to 5.8%, which is significant for UK housing and the consumer, and provides a further boost to the compelling potential opportunity available in UK Residential Mortgage Backed Securities (RMBS). These are securitised assets backed by pools of thousands of residential mortgages.
“Amidst the strong fundamental backdrop for UK RMBS transactions, we believe there is still significant value in the sector.”
UK interest rate expectations are significant for the UK residential property sector as they are the primary driver of mortgage lending rates. The 2 year UK swap rate (which directly correlates to 2 year fixed mortgage rates) has fallen from 6.22% on 7 July to 5.54% on 19 July. We should see this significant downwards adjustment feed through into lower mortgage lending rates which is wholly supportive for the UK residential property sector and therefore UK RMBS generally.
Strong fundamentals and significant value
The decline in interest rate expectations in combination with lower inflation and tight labour should ease cost of living pressures, contain delinquencies and further help the robust collateral performance of UK RMBS transactions we have experienced to date.
Amidst the strong fundamental backdrop, AAA UK RMBS all-in yields currently stand at c.6.1% which is 40bps more than those on offer for AA GBP denominated corporate bonds. Given that most UK RMBS issuance has a credit rating of AAA (e.g. higher credit quality than the UK Government), we believe this represents a compelling opportunity.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.
