Market commentary

Economic background

• The economic background looks more problematic than at any time in the last ten years. The economy has been hit by a negative shock to output, while at the same time being hit by a number of negative shocks to inflation. 
• The credit crunch has affected the price and availability of credit, which is starting to weigh on economic activity. Sharply higher food and energy prices together with a fall in the exchange rate, which is putting upward pressure on imported goods prices, have pushed up producer output price inflation to 5.7% - the highest since 1991. 
• These shocks are reflected in the Bank of England’s latest Inflation Report, published last week. The Bank’s central projection is for economic growth to slow from a little under 3% at the end of 2007 to a low of around 1.5% at the end of 2008. And consumer price inflation is projected to rise from 2.2% in January to a little above 3% by the third quarter of this year. The inflation outlook means that the scope for monetary relaxation is more limited than financial markets have been expecting. 
• The slowing in growth in the first half of this year is expected to be very sharp.  Indeed, the Governor has warned that two successive quarters of economic contraction – economists’ definition of recession - was not very far off the Bank's central projection. A significant squeeze on household discretionary incomes is in prospect, with the Governor saying that Britons must face up to a "genuine reduction in our standard of living". 
• But as problematic as the near term outlook is, the Bank is not forecasting a severe recession.  The economy is still expected to grow. And the pace of growth should start strengthening towards the end of this year and return to its long-term trend rate during the course of 2009. Inflation is expected to fall back to the 2% target by the middle of next year even if the Bank cuts rates by a further 0.25% to 0.5% this year.

Housing and mortgage market developments

If the Bank is right – and it admits to considerable uncertainty around its central projections - the housing and mortgage markets should start to stabilise later this year, with the prospect of some strengthening in house sales and, eventually, house prices during the course of 2009. 

The rise in gross mortgage lending in January, to £26.5 billion, which marks a significant (and unusual for the time of year) rebound from December, is unlikely to indicate a change of fortune.  Unsettled market conditions may have affected the progress of approvals to completions in recent months.  And the recent trend in approvals is compatible with somewhat softer gross lending volumes over the next couple of months.

Chart A: Mortgage approvals and gross mortgage lending

Source: Bank of England, CML
Notes: Not seasonally adjusted.  Mortgage approvals include house purchase, remortgaging and other.

Further ahead, things look a little more positive. Although RICS reported renewed downward momentum behind new buyer enquiries in January, the bigger picture is that momentum might be stabilising.  If this is indeed the case, it is likely to be followed by a stabilisation in mortgage approvals for house purchase.

Chart B: New buyer enquiries and mortgage approvals for house purchase 

Source: RICS, Bank of England
Notes: New buyer enquiries is the balance between the percentage of survey respondents reporting that the number of buyer enquiries is increasing and the percentage reporting that it is falling.

12 March Budget

This year’s Budget is scheduled for 12 March. 

While there are always surprises, the  Chancellor may well announce his intention to consult with lenders on the possibility of establishing standardised documentation for covered bonds and mortgage backed securities - the so called 'gold standard' – and proposals to encourage the take up of long-term fixed-rate mortgages following the Treasury’s housing finance review. As yet, little detail is available. 

We will set out the key changes we would like to see in the Budget in our next News and Views, to be published on 4 March.

Economics team

1. Jim Cunningham
2. Paul Samter