Market commentary

18 April 2008

This month's cut in Bank rate has not been reflected in wholesale money rates and so has only benefited some mortgage borrowers. The shortage of mortgage funding remains a serious problem. It is holding back transactions and weakening prices. In the CML's view, the tripartite authorities should use unconventional measures to address the glut of illiquid assets constraining the ability of lenders to make new loans. The solution the Bank is rumoured to be working on looks promising, although it is difficult to assess until more detail emerges.

No sign of an end to the credit crunch

The cut in Bank rate to 5% this month has scarcely been reflected in the wholesale money rates that are more relevant to funding mortgages.

In a more normal environment, current interbank rates would be compatible with a Bank rate of 5.75%. So the cuts since December have done no more than offset the credit tightening impact of the credit crunch.

Chart 1: Bank rate and three month interbank rate

Source: Bank of England

This is reflected in mortgage rates, which have not fallen by as much as Bank rate in recent months. Despite this, mortgage demand appears to be fairly strong. Or at least stronger than the industry's capacity to satisfy it at current interest rates.

There is some speculation that the credit crunch has passed the worst. In our view this is too early to call. The shortage of mortgage funding remains a serious problem, that is holding back transactions and weakening prices.

Economic outlook weakens

The impact of the credit crunch is reflected in the latest IMF forecast for UK growth this year. This has been revised down to 1.6% from a forecast of 2.3% last October.

This is somewhat below the government's Budget forecast of 1.75% to 2.25% and the central projection in the Bank of England's February Inflation Report.

It is compatible with a weakening labour market and a modest rise in unemployment. We should expect a couple of very weak quarters this year, but we still seem likely to escape an outright recession.

House prices soften

Latest data confirm that house prices are softening. On both the Halifax and Nationwide measures, prices rose by about 20% between the beginning of 2005 and last summer.

The Halifax measure has since fallen by 4% and the Nationwide measure by 3%.

Chart 2: House prices

Source: HBOS, Nationwide

The latest RICS survey provides little comfort about the immediate outlook. The price measure was the most negative in the survey's 30 year history and confidence in the price and sales outlook point to a worsening picture in the months ahead. New buyer enquiries are at their lowest level for five years. The weakness in demand reflects, at least to some extent, the lack of credit available.

Approvals and gross lending

In view of softer house sales and prices, it is somewhat surprising that gross mortgage lending has remained as strong as it has.

Lending totalled £50.9 billion in January and February, down only 2.5% on the same period last year. And we estimate that it picked up to £26.3 billion in March, in spite of the Easter holiday being unusually early this year.

Chart 3: Total mortgage approvals and gross advances

Source: Bank of England
Note: Not seasonally adjusted

But, again, the outlook is not encouraging. Mortgage approvals have been lower than gross advances in six of the last seven months and in line with gross advances in the seventh. There will be a much softer than usual seasonal pick up in gross lending over the next few months if there is one at all. And the approvals data suggests this will be strongly directed towards remortgaging, with lending for house purchase and net lending particularly soft.

Outlook

Housing and mortgage market activity look set to be somewhat weaker this year than built into our forecasts published in October. House prices now look set to fall and sales to weaken by more than 15%.

If the credit crunch persists, and there is a shortage of mortgage funding available to meet demand, net lending this year could be as low as half the £108 billion seen last year, as our Chairman made clear in a speech on 11 April.

But it does not have to be this way.

It is time for more inventive and determined action by the tripartite authorities. Unconventional monetary policies need to be used to address the glut of illiquid assets constraining the ability of lenders to manage their balance sheets and make new loans. The Bank of England needs to be much bolder in its use of liquidity-enhancing open market operations and it needs to start focusing on getting the RMBS market functioning again.

The media have reported that the Bank is to launch a programme that would temporarily allow organisations to swap RMBS for liquid government securities. It is difficult to assess the measures until more details emerge. It will be important that as wide a range of institutions as possible can access any scheme. But, in principle, such a move could help improve matters.