If you thought 2008 was bad…

Last year was one of the most turbulent the mortgage market has seen for decades. Here, Building Societies Association economist Andrew Gall chronicles the key events and offers an insight into the gloom ahead

Given the turmoil seen in the financial markets in the past 18 months and the widely held belief that property prices will fall further it is not surprising that activity in the mortgage and housing markets has been so subdued.

According to the latest data from the Bank of England, total net lending in November 2008 was just £479m compared with £8.8bn in November 2007. However, it is worth noting that of the £479m of net lending in November, £422m was lent by building societies.

In total, just 25,000 mortgages were approved for house purchase in November 2008 compared with an average of 38,000 approvals in each of the previous six months, and much less than the 81,000 loans approved for house purchase in November a year earlier.

This reduction is likely to be a result of the dramatic 1.5% cut in the Bank of England base rate at the start of the month which resulted in lenders altering their product ranges and potential borrowers reappraising the mortgage market.

Despite this gloomy picture, our Property Tracker survey carried out in December showed that a growing proportion of adults think that now is a good time to buy property – 46% agreed to some extent that it was a good time to buy compared with 34% in September and 27% in June – possibly because of improving affordability (see table on this page).

But those who agreed most strongly also tended to be most concerned about losing their jobs, and were most likely to believe that lack of access to a mortgage would prevent them from buying, What is most likely to stop you buying a house?

Overall, the most significant barrier to purchase according to the tracker is lack of job security. This was chosen by 58% of respondents – up from just 12% in June 2008 – showing how rapidly confidence in the wider economy has fallen. And it’s hardly a surprise that affording monthly mortgage payments has be-come a less significant barrier as interest rates have fallen.

The Bank’s survey of credit conditions also suggests that demand for mortgages for house purchase and remortgaging remained fairly stable in Q4 2008. But the Bank’s survey also shows that lenders continued to tighten credit conditions in the last quarter of the year due to the worsening economic outlook and expectations of further falls in house prices, as well as increased cost and reduced availability of funds.

These trends are all expected to continue during Q1 2009.

The survey also found that default rates on mortgages had risen in Q4 2008, as had losses on loans in default as a result of lower house prices. These trends are also expected to continue into this year as unemployment rises.

In recent months forecasts for key economic variables have been revised downwards radically, and are likely to be revised down further.

Economic output declined by 0.6% in Q3 2008 compared with the previous quarter, with a further 1.5% fall in output in Q4 2008.

The consensus is that the economy will contract in 2009, with the latest average of independent forecasts collected by the Treasury predicting a fall of 1.5% compared with a year earlier.

The rate of inflation shown by the Consumer Price Index fell rapidly from a peak of 5.2% in September 2008 to 3.1% in December, and is expected to fall further in 2009.

The fall in the rate of inflation shown by the Retail Price Index has been even more dramatic because of the inclusion of mortgage interest payments, with annual RPI inflation falling to 0.9% in December 2008 after being as high as 5% in September.

So the economic outlook has deteriorated sharply and the focus has shifted to the possibility of a general fall in prices caused by falls in commodity prices, the temporary effect of the VAT reduction and reduced demand.

If deflation is sustained it can bring serious problems as big expenditures are postponed and debt becomes harder to service as prices and wages fall.

The Bank’s Monetary Policy Committee has cut the base rate aggressively in recent months, reducing it to 1.5%. Members of the MPC say they are prepared to consider reducing the rate to zero or near-zero, and look at other ways of stimulating the economy such as buying long-term government bonds or mortgage-backed securities.

Part of the package of government measures announced on January 19 put in place a framework to enable the Bank to buy assets directly. But with interest rates at their present levels it should be borne in mind that further cuts in the base rate would pose a big challenge for institutions such as building societies that rely on attracting retail savings to fund new lending.