Business Analysis: Collapse in home loans could trigger consumer slowdown

Mortgage lending for both house purchases and equity withdrawal has slowed dramatically, according to figures released yesterday by the Bank of England.

Mortgage lending for both house purchases and equity withdrawal has slowed dramatically, according to figures released yesterday by the Bank of England.

The number of mortgage approvals for house purchases fell for the sixth month in a row to hit a nine-year low of 77,000 in November, the Bank said. The volume of the loans fell to £6.46bn, the lowest since June 2002.

And the Bank said mortgage equity withdrawal - loans on a property for reasons other than house purchase - slowed for the third quarter in a row.

Homeowners released £13.4bn from their homes over the three months to September, down from the peak of £16.6bn in the summer of the previous year.

Coming alongside early indications of poor Christmas trading on the high street, these latest signs of rapid cooling in the property market will provide an early test of the Bank's controversial forecast that a fall in house prices would not trigger a collapse in consumer spending.

In its November Inflation Report, the Bank published research showing the link between the two variables had broken down. A few days later, the International Monetary Fund warned that a house price crash could have a "significant" effect on consumption.

Analysts say it is too soon to say who was right. But as Stephen King, the managing director of economics at HSBC and a columnist for The Independent, puts it: "Perhaps 2005 may finally be the year when we discover the true relationship between house prices and consumer spending."

Referring to the decline in mortgage approvals, Simon Rubinsohn, the chief economist at Gerrard fund managers, said: "The drop over the past 12 months has been stunning - 43 per cent year on year. That even exceeds the collapse in activity seen at the tail end of the 1980s."

The Bank of England figures also indicated that consumers exercised restraint before Christmas, with borrowing on credit cards and other unsecured loans weakening in November. Consumer credit increased by £1.4bn, £100m less than the previous month.

At the same time Woolworths reported a "disappointing" December trading session. More significantly, sales at its out-of-town Big W stores, which focus on so-called big-ticket items, dropped 8 per cent, while its MVC music and video stores fell almost 5 per cent. Toys, games consoles and DVDs also slipped.

In other words, there is a hint that shoppers were less willing to spend their money on discretionary items, at least in Woolworths.

Trevor Bish-Jones, its chief executive, said: "There have been four interest rate rises, utility bills and fuel prices have gone up - people can only spend a one pound note once. If people's mortgage payments are going up, their disposable monthly income must by definition be going down."

In the run-up to Christmas several retail chiefs made warning noises about the impact the turnaround in sentiment in the housing market would have on their sales.

John Clare, the chief executive of Dixons, blamed the softer housing market for the "dent" to consumer confidence and warned big-ticket products will be hit more than low-ticket ones.

Dixons is among nine blue-chip retailers preparing to issue their festive trading statements in the coming days, alongside Next, Marks & Spencer and Matalan.

Evidence from analysts who measure footfall through major shopping centres indicates the number of visitors in December was down on 2003 - although there had been a post-Christmas pick-up.

The research carried out by the Bank, which is forecasting "modest" house price falls, showed the correlation between house price inflation and consumption growth had broken down since 2001. It said it was likely the simultaneous rise in house prices and retail sales was caused by a common third factor, such as consumer confidence or wage growth.

The implication is that if property prices did not inflate spending on the way up, it won't puncture it on the way down. This view does not carry much weight in parts of the City.

HSBC's Mr King said the Bank would be monitoring any impact on consumer spending rather than any falls in house prices themselves.

"That will increasingly show that the recent success of the economy was based on the housing boom and that in its absence it will slow more now as a result, so the Bank will be forced to cut rates later in the year," Mr King said.

Alan Castle, a UK economist at Lehman Brothers, said yesterday's housing market figures pointed to falls in house prices over the next four to six months.

He said a key question was whether the price-cutting before Christmas was just the latest development in a structural shift, or a desperate measure to capture shoppers' cash that would be unsustainable. "We continue to expect rates to stay on hold through 2005 with a bias towards rate cuts from the middle of the year," Mr Castle said.

City traders are increasingly betting that the next move in rates will be down. The pound dropped 1 per cent against the dollar yesterday, falling to $1.8829 - down from $1.95 just two weeks ago.

Of course, underlying this whole debate is the old chestnut of whether - and if so, how far - house prices will fall. The housing industry sees little or no growth this year, with forecasts between minus 2 and plus 4 per cent. But independent analysts are more gloomy. Deutsche Bank forecasts a fall of up to 15 per cent this year.

Yesterday the Centre for Economics and Business Research became the latest, pencilling in a cumulative fall of some 10 per cent over the next three years - 1.3 per cent this year, 6.0 per cent in 2006 and 2.2 per cent the following year.

Mark Pragnell, the CEBR's director, said: "We expect interest rates will be cut in 2006 and beyond, in order to bolster consumers' confidence and stabilise the housing market."

Capital Economics expects a 20 per cent drop over three years. Ed Stansfield, its property economist, said: "Today's figures provide further confirmation that the housing market correction has begun."

But the Bank receives support from a significant quarter - David Miles, the author of an exhaustive report into the UK mortgage market and now chief UK economist at Morgan Stanley. "On the surface, the impact of a 20 per cent decline seems likely to be huge - in value terms it is worth 60 per cent of GDP," he said in a recent report with fellow economist Melanie Baker.

"It is a clear downside risk," Ms Baker said. "But our central case is that consumer spending does not fall in response to big housing market movements." Since there was no clear evidence that the housing boom fuelled consumption, it was not a compelling argument that a reversal would slow consumption, she said.

A key difference between now and the early 1990s, when a housing crash coincided with a consumer recession, is the more robust state of domestic finances. Fifteen years ago indebted homeowners who lost their jobs were forced to sell up. Now, with record employment and low mortgage rates, there is little pressure on people to sell, driving down the number of transactions as sellers sit out the slowdown.