I do not believe that anybody was expecting that Sir James Crosby’s analysis of mortgage finance would find the magic bullet to end the mortgage and housing markets’ current woes, but I think that most of us were expecting something slightly more positive than was contained in Crosby’s Interim Review, published at the end of July.
For me, it was most disappointing that Sir James never addressed the issue of what level of mortgage finance, in terms of new lending, it would be appropriate for policy makers to target. I do not believe that anyone would recommend an immediate return to new lending of over £100bn a year. But what level would be appropriate?
The market is currently running at under £40bn a year and seems certain to slide lower. This lurch over the past year from feast to famine is already having significant adverse effect on other sectors of the economy and this can only get worse. But if Sir James is to be believed, there is nothing that anybody can do about this: we just have to wait until the market re-adjusts. And, apparently, if that means further declines in mortgage lending and further distress in the general economy, then so be it. According to Sir James, there is: “a broad consensus that such a significant and prolonged shortage of mortgage finance must take its toll of both (the housing market and consumer spending)”. I am far from convinced that, even setting aside their vested interests, house-builders or mortgage brokers would form any part of this consensus.
So, the salvation of the mortgage and housing market would appear to lie solely with the prospects for the wider economy. The sooner the Bank of England’s Monetary Policy Committee (MPC) is able to reduce interest rates, the less painful the market-led adjustment to the mortgage finance shortage will be. But what hope is there of early and significant cuts in base rate?
Well, based on the Bank’s analysis, not a lot. The tenor of Mervyn King’s presentation of the August Inflation Report followed his previous (and unimpeachable) line that the MPC’s prime objective is to secure control over inflation and that because of the current high rate of inflation, there is no scope to relax monetary policy.
But, in relation to the prospects for inflation, the Bank appears markedly pessimistic. Now it seems quite reasonable that the Bank should forecast that the inflation rate will peak at over 5% at sometime in the next four or five months, particularly given the sharp rise to 4.4% in July (mortgagesolutions-online.com 18/08/08, p6). it is not unreasonable to forecast that the inflation rate will remain above 2% throughout next year, even on the assumption that base rate remains at 5% and that the economy shows virtually no growth over the next twelve months. But the Bank would be gloomy to judge that the risks to this forecast remain on the upside.
Paradoxically, the Bank is optimistic in its forecasts for growth in the medium term. Despite the Bank’s assumption that base rate will remain at 5%, it forecasts that UK growth will recover quite strongly in the second half of next year and gain further strength through 2010, largely on the back of strong export growth fostered by the improvements in competitiveness arising from the depreciation of sterling.
This suggests a decidedly grim outlook for the mortgage industry. Interest rates will stay high for the next twelve months while inflation is brought under control and remain high thereafter, as growth returns to its trend rate. We can only hope that the Bank has got its forecasts wrong and that the scope for policy initiatives is much greater than these predictions imply. n
