Bank warns mortgage lending will be slashed further

Services sector slows and business confidence falls, while pressure grows for interest rate cut
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The Independent Online

Households face a further squeeze on their finances as banks and building societies slash mortgage lending and increase prices further in the coming months, the Bank of England warned yesterday.

Mortgage lenders have been tightening credit conditions, reducing loan-to-values and raising interest rates because of the financial crisis and concerns about the economy, according to the Bank's latest Credit Conditions Survey. A host of lenders have withdrawn products, suspended lending or closed their doors as borrowers scrabble to secure the best deals.

The Bank's survey found that lenders expected the squeeze to intensify in the next three months, with further price increases and a bigger reduction in credit than in the first quarter. Lenders also expect mortgage defaults to increase.

Demand for house-purchase mortgages was broadly flat but lenders expect demand to fall in the next three months. Remortgaging demand jumped by more than forecast and is expected to increase further as borrowers coming to the end of fixed or discounted deals try to refinance their loans. First Direct suspended mortgage lending and the Co-operative Bank pulled its two-year rates this week after they were deluged with customers trying to secure good rates.

There are fears that the mortgage drought could exacerbate falls in house prices that are already underway. The International Monetary Fund said yesterday that central banks in countries where housing and the wider economy are closely linked should pay more attention to house prices when setting interest rates.

The Bank of England's Monetary Policy Committee meets to set rates next week. The drying up of credit and a sharp slowdown in the services sector will increase pressure for a cut.

The gloomy news followed Wednesday's figures from the central bank that showed mortgage approvals near a decade low in February. A surge in unsecured lending suggested that people were financing spending with credit cards because they could no longer borrow against equity in their homes.

Howard Wheeldon, senior strategist at BGC Partners, said: "The last 48 hours have been very bad for anyone attempting to view the outlook for the UK economy. We are in a mess and the message for UK consumers is that it is going to get worse."

Corporate credit also contracted in the first quarter, particularly for the commercial realestate sector, and will be tightened further. A big increase in spreads is expected and terms and conditions will be tougher as credit lines are reduced and covenants are strengthened.

Banks and building societies are suffering from a shortage of funding for their loans after the wholesale markets shut down in the summer. But lenders cited fears about the economy and risk aversion rather than lack of funds for reining in their loans.

The closely watched Chartered Institute of Purchasing & Supply survey of the dominant services sector hit its second-lowest level since May 2003 in March after a surprise jump in February. Business confidence also dropped, but input prices rose to a survey high, underlining the dilemma facing economic policymakers.

The Bank of England's Monetary Policy Committee is balancing slowing economic growth and the financial crisis with inflationary pressures from rising energy and commodity prices in the most difficult year since its inception 11 years ago.

Economists said the barrage of miserable figures and trends made a rate cut at next week's MPC meeting highly likely. The committee has cut rates by a quarter point twice since December, to 5.25 per cent. But lenders are not passing on rate cuts to consumers because they face pressure from soaring funding costs in the wholesale markets.

Vicky Redwood, UK economist at Capital Economics, said: "We think the balance is now tilted in favour of a cut next week. The MPC will have its inflation concerns but we've had enough evidence of a deterioration in growth."