Small rise in base rate could shrink lending volumes

A modest rise in interest rates in the next two years would have damaging consequences for lending that might have been underestimated, Hometrack has warned.

The firm has forecast that the Bank of England base rate will start to rise next year to around 1%, moving to 2% in the longer term.

But Gary Styles, risk and econo-mics director at Hometrack, says that with inflation climbing higher and the need to support sterling the industry should be prepared for the possibility of rates hitting 3% by the end of 2011.

On that basis Hometrack’s fore-cast of £17bn in net lending in 2012 would be pushed down to £4bn a year. Styles says this represents about half the level seen at the market’s low point in 2009.

An interest rate rise from 0.5% to 3% by the end of 2011 would suggest mortgage rates of about 6.3%.

Styles says: “This scenario is still likely to underestimate the impact on lending volumes as lenders may tighten criteria again in the face of lower house prices and an increased likelihood of default.”

Hometrack is sticking to its main forecast of a slow housing market recovery, with prices and lending rising slightly in the next few years.

But Styles adds: “Only a small change in the interest rate assump-tion produces a dramatic shift in the prospects for the lending market – something we should all factor into our assessments.”

Paul Walshe, partner and head of lender services at Moore Blatch, agrees that the worst may not be behind us. He is concerned that while the residential property market has flatlined there may be another crisis to come in the commercial property sector.

Servicing firm Hatfield Philips recently warned that the Financial Services Authority’s risk outlook paper underestimates the scale of the commercial property crisis.

Walshe says: “A commercial collapse matters because lenders would have to shore up balance sheets that have already taken a hit on residential lending before looking at new lending. This would affect borrowers who are already in trouble.”