Equity withdrawal surges to highest level since late 1980s

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The dilemma the Bank of England faces as it struggles to avert a UK recession was highlighted by separate figures yesterday showing a fall in company profitability but a surge in remortgaging.

Mortgage equity withdrawal ­ the borrowing by homeowners against the value of their house to finance consumption ­ surged over the summer to its highest rate since the 1980s housing boom, the Bank of England said.

The latest evidence of a continuing boom in household spending and borrowing came as separate figures showed business' rates of return had slumped to a nine-year low.

Homeowners borrowed more than £5bn in the second quarter by remortgaging their homes, up from £3.5bn in the first quarter and the highest since autumn 1988. As a proportion of income, it surged to 2.9 per cent. The figures are bound to ring alarm bells at the Bank even though households are not borrowing anything like the 8 per cent of their income seen in the late 1980s.

Mortgage equity withdrawal is seen a sign homeowners are betting on higher house prices in order to fund consumption.

The figures are a sign the cut in interest rates from 6.0 to 4.5 per cent in just 10 months has stimulated a surge of activity in the housing markets. Mortgage rates are now at their lowest for around 45 years.

The Bank has made clear it is cutting rates to boost domestic demand to offset the slump in manufacturing orders in the face of the US slowdown and the strength of the pound.

The extent of the difficulties in the corporate sector was highlighted by figures showing companies' profitability had fallen sharply even before the US terrorist attacks.

Manufacturers' rates of return in the second quarter of the year fell to 4.5 per cent, the lowest since 1992. In the services sector the rate dropped to an eight-year low of 12.4 per cent.

Overall, the net rate of return for non-financial companies fell to 12 per cent, the lowest since 1995. It would have been lower but for a record 42.3 per cent rate of return enjoyed by the UK North Sea oil and gas extraction industry.

Some economists are concerned that a consumer boom will exacerbate existing imbalances.

Richard Jeffrey at Charterhouse Securities, said mortgage equity withdrawal allowed people to borrow against future income. "The problem is that interest rates can go up and consumers are vulnerable to high levels of debt," he said.

Mr Jeffrey said he was worried the higher borrowing and spending now rising, the greater the risk of a sudden collapse next year. Unless there was a revival in world demand that boosted the UK's export sector recession could be "unavoidable", he said.

But most economists believe the UK will escape a full-blown slump. Robert Jukes at CSFB said the Bank was right to cut rates to boost the consumer economy. "For the time being the consumer is the mainstay of our growth so it is something to be supported."