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Lower rates are not the answer

Sally Laker, managing director of Mortgage Intelligence, questions the accepted wisdom that lowering interest rates is the way out of our economic malaise

Mortgage funding liquidity fuels the UK property market and without it there is no hope of a market recovery in the foreseeable future.

This is something the government acknowledged at an early stage but little decisive action has been taken until recently, and we are likely to see more friction between the government and the banking sector as further attempts to kick-start the economy are announced during 2009.

On a positive note, chancellor Alistair Darling announced on January 19 that he is setting up a Bank of England fund to try to get banks lending again. The Bank is tasked with creating a fund worth up to £50bn to help the corporate sector. It will take securities and assets in return for that money going into the economy.

The initiative will give the Bank the option of using asset purchase for monetary policy purposes if it deems that this will help the economy meet its inflation targets.

Furthermore, implementing the recommendations made by Sir James Crosby in his recent review of the mortgage market – which include guaranteeing new mortgage securities – is a big step in the right direction and should ease the funding of mortgage loans in the future.

The government will provide full or partial guarantees attached to AAA-rated securities from April, with those lenders able to access the original credit guarantee scheme being eligible for this further scheme.

Along with these two moves, the government has revealed that Northern Rock will no longer pursue a policy of rapidly reducing its mortgage book.

Taken together, these initiatives could have a positive effect on the mortgage market and should be welcomed. However, it remains to be seen whether enough has been done to re-energise the sector, given the scale of the issues facing us.

A recent forecast by the Royal Institution of Chartered Surveyors shows that continuing caution among lenders and a worsening economic climate is likely to result in house prices falling by about 10% in the next 12 months. But it predicts a 10% increase in sales during 2009, based on the evidence of recent RICS surveys that suggest market activity may have bottomed out.

RICS says new buyer enquiries have climbed to their best level since October 2006, and the key to turning these enquiries into sales is the availability of funding. 2009 is going to be a big challenge for all of us and I question whether government claims that mortgage lending will return to somewhere near 2007 levels this year are accurate.

Also, I don’t agree with Darling’s view that the government has been doing everything it can to increase the supply of mortgages, although the January 19 announcement should help in this regard.

The government initiative to drop interest rates to 1.5% has bound and gagged lenders, whose back books are now at such low rates that they are unlikely to be making enough money on their deals.

And there is no chance of home owners remortgaging because there is little point with rates as low as they are. That stops the flow of funds and paralyses the remortgage market which represented 45% of total lending just a few years ago.

And if consumers need to remortgage because they want additional cash to improve their property, the chances are they will need too high an LTV against a falling property value so they will be stuck too. Furthermore, lenders that used their savings offerings to fund mortgages are now being forced to offer rates below inflation – why should consumers want to save more than the bare minimum?

My point is that a sustained period of low interest rates is one of the reasons we are in this mess, and reducing them even further has made the situation worse. So when I read that Prime Minister Gordon Brown is to force lenders to lend I have to wonder – how?

Lowering interest rates may increase consumer spending but because so many industries are linked to the housing market, if funding continues to fall there will be an awful lot of job losses. For someone with no job and no income a slightly lower interest rate is of limited value.

According to the BBC, neither the banks nor the government are aiming for a return to the levels of lending seen in 2007 nor do they want to see a return to banks relying solely on money from savers. They say that would lead to a collapse in house prices.

While I broadly agree, decisive action is needed and fast. The government seems to have grasped the nettle now but it remains to be seen if it will be enough, given the damage already done to the mortgage market.

However, we should applaud the government for finally setting out its stall and making its move. Let’s just hope it is the right one and that it is implemented well and quickly.

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