Last August, the credit crunch that had been rocking the US hit British soil. In just 12 months, the impact on house prices, the cost of living and the economy has been dramatic. Liam Tarry looks at the credit crunch one year on and asks what the future holds.

Northern Rock

Although the credit crunch first struck in August, when the credit markets froze, it wasn’t until it claimed its first victim – Northern Rock – in September that most people started to sit up and take notice. The first run on a UK bank in over 140 years has claimed hundreds if not thousands of headlines ever since, making credit crunch a household name.

Northern Rock, the mortgage giant and high street bank famous for being the first lender to offer 125% loans, found itself unable to borrow on the money markets to fund its lending. As such, the bank was forced to go cap in hand to the Bank of England as a ‘lender of last resort’, causing panic-stricken customers with the bank to queue outside branches across the land to withdraw their money – despite assurances from the government that it was safe.

One year on, and Northern Rock has been nationalised, and all of its original board have stepped down. Even Ron Sandler, the man brought onboard in February by the government to run the bank, has stepped into a non-executive role. From 1 October, Gary Hoffman, currently an executive director at Barclays, is to take over the reins as the bank’s chief executive. He has vowed to return Northern Rock to private ownership as soon as possible.

In order to do this, the bank must fulfil Sandler’s plan to pay back its debt to the government (and the taxpayer) and shrink its mortgage book by giving the cold shoulder to borrowers coming to the end of their deals.

Mortgages

A major impact of the credit crunch has been fewer and more expensive mortgages across the board. According to data provider Moneyfacts, the average two-year fixed rate stood at 6.58% in August 2007, standing at around 6.95% today. But just three weeks ago, the average two-year fixed-rate hit a 10-year high of 7.08%, due to borrowing on the money market hitting a peak of 6.52% in June.

“Such a large increase in mortgage rates over the past year will no doubt have come as a real shock to borrowers coming to the end of their deals,” says Darren Cook of Moneyfacts. “But potential borrowers without a deposit will have been worst affected as the 100% loan-to-value mortgage market no longer exists as lenders don’t want to be exposed to falling house prices.

"For anyone requiring more than 85% loan-to-value today it will certainly be difficult to secure borrowing at a reasonable rate.”

Moneyfacts data also shows that there are only around 3,500 mortgage products available today, compared with the 15,599 available last summer. Mortgages for those with a patchy credit history, or sub-prime mortgages are still available, constituting around 38% of the total residential mortgage market.

According to the Bank of England’s latest figures, mortgage lending has fallen to the lowest level since October 2000 - a total of £3.1 billion was lent in June, well below the £9.9 billion witnessed in June 2007. Mortgage approvals have also fallen, with only 165,000 new loans agreed during June, down from the 214,000 approved three months earlier.

The upshot of all of this, is that increasing numbers of people are unable to secure finance to get on the housing ladder. First-time buyers and those with stretched incomes have been the the worst hit, although according to some experts, people that need large loans are also struggling. How long the mortgage drought continues is hard to say, although in the past month mortgage rates have started to fall slightly, suggesting a faint light at the end of the tunnel.

Housing market

A knock-on effect of a more restricted mortgage market has been sinking property prices. Although average house price inflation began to slow before August 2007, the onset of the credit crunch intensified the decline and turned the predicted slowdown into a full-on downturn.

At the start of August 2007, the average house price stood at approximately £183,898, according to the Nationwide. Today that figure is £169,316 which represents an annual fall of 8.1%.

How long the falls will continue depends on the health of the mortgage market – simply put, without available loans, people can’t buy or sell, and prices therefore sink. Figures such as 50% falls have been branded about, but the reality is, no one knows what will happen in the short-term.

The good news, however, is that in the long-term house prices will start to rise again. According to the National Housing Federation, house prices will increase by 25% over the next five years, first starting to pick up in 2010.

The logic behind this is that, in the UK, demand for housing outweighs supply – with limited space to build new properties and a growing population, house prices will eventually have to start rising again.

The economy

The ripples from the credit crunch have not just been confined to the mortgage and housing market - they have affected the whole economy. Although the Bank of England has held interest rates at 5% since April, rising food and fuel costs have impacted on the government’s official measure of inflation. The consumer prices index (CPI) has increased from 1.8% in August 2007 to 3.8% today - well above the government’s target of 2%.

The Bank of England is, of course, extremely worried that an extended period of above-target consumer price inflation resulting from higher utility and food prices and a markedly weaker pound could lead to a long-lasting rise in inflation expectations.

“Inflation expectations remain far too high for the Bank of England's liking,” says Global Insight’s chief economist Howard Archer. “It seems unlikely that the Bank of England will cut interest rates in the near future, and it is very possible that the central bank’s next move could be to raise interest rates, which would clearly be very bad news for the housing market.”

The latest figures show that gross domestic product grew by just 0.2% between April 2007 and June this year – the lowest period of growth for three years. Between the same period in 2006 and 2007, the growth rate was a much healthier 2.3%.

The fear now is that Britain in on the brink of a recession. This is defined as two quarters (six months) of negative growth. While we aren’t quite there yet, economists say there is over 50% chance that a recession will hit before the end of 2008.

The cost of living

According to the Office for National Statistics, the price of food has risen sharply over the past 12 months. Eggs are now 33.3% more expensive than this time last year, while price tags on cheese (15.8%), milk (13.5%) and bread (13%) have also increased.

The price of oil is also 91% more expensive than it was this time last year, meaning our wallets also feel the pinch when it comes to filling up at the pump or heating our homes.

Louise Doherty, a spokesperson for petrolprices.com, believes that motorists will continue to be hit hard in the pocket for some time to come. “Last August the price of a litre of unleaded was 96.5p, now that figure stands at £1.17, despite falling two pence over the last week. Even if supermarkets engage in a cut-price war, I don’t see the price of unleaded dropping below the £1 mark anytime soon.”

Recently, both EDF Energy and British Gas have passed on the cost of rising oil prices to consumers, spelling even more bad news for cash-strapped customers this winter.

Figures from theenergyshop.com show that gas and electricity prices rose by 14.5% after the first round of hikes this year, but Joe Malinowski, a founder of theenergyshop.com, believes this will now hit 40%.

“The writing has been on the wall for some time now, but the latest hikes will take the average energy bill to well over £1,100, and this will be truly painful,” he says. “I would urge customers to cap their plans immediately.”

Savings and Investments

But it’s not all bad news. As banks and building societies continue to cry out for funds from the public, savers have been able to profit from some of the most attractive savings rates seen for over seven years - especially as the government increased the protection on savings to £35,000 following the run on Northern Rock.

According to Moneyfacts, before the credit crunch took hold the highest rate available was 6.7% on Birmingham Midshire’s one-year fixed-rate account. After briefly breaking the 7% barrier following the collapse of Northern Rock, rates continued to rise – peaking at 7.17% last month.

However while this may be a positive effect from the credit crunch, Rachel Thrussell, head of savings at Moneyfacts is sceptical for how long it can last: “In a few months time when all these attractive one-year deals mature what will institutions do? Their strategy was for the short-term, and with the credit crunch continuing I can’t see them maintaining rates at such high levels for too long.”

Unlike savers, investors have had a rocky year thanks to turbulence on the stockmarket. But experts say there are still returns to be made.

Ben Yearsley, an investment manager at Hargreaves Lansdown, believes the funds that have performed the best have been those investing in commodities.

“Flying in the face of the credit crunch, mining, oil and agricultural funds have all posted strong returns in the past 12 months,” he says. “Whereas returns from those funds with exposure to banks, retail and aerospace have all been disappointing.”

Pensions

Falling stockmarkets have also had a knock-on effect on pension funds. In August the FTSE 100 suffered its worst day in more than four years closing 3.7% lower, and further falls occurred in October and January – when the FTSE 100 index fell by 5.5%.

However Danny Cox, head of advice at Hargreaves Lansdown, states that falling stockmarkets do give potential for pension investors in it for the long-term.

“Regularly saving into a pension fund while stockmarkets fall is attractive,” he says. “Not only does it lessen the impact of volatility, the benefits of pound cost averaging mean they will be picking up stocks cheaper and will profit when stocks bounce back.”

Cox also notes that annuities have become more attractive due to the credit crunch. “Annuity payments are at a six-year high as the credit crunch has forced providers to attempt to bring in funds through their front doors,” he says. “However it is a double-edged sword as those with income drawdown plans have suffered due to the volatile equity markets.”

The future

As you can see, the credit crunch has brought about both winners and losers – but what does the future hold? Unfortunately the International Monetary Fund sees no end in sight to the credit crunch.

Its latest global financial stability report makes for gloomy reading, warning that banks are under renewed stress and that falling house prices and slowing economic growth are hitting credit.

It’s a view held by the majority of economists polled by news agency Reuters too. In fact, the majority of the 87 economists polled believe that the credit crunch will last well into 2009 and possibly 2010, and this has the potential to cause even more misery for cash-strapped Brits looking to ease their worries.

Bob Surges, a director at Goldman Sachs-owned mortgage lender Money Partners, is not hopeful that the credit market will return to normal conditions anytime soon.

“We are in a grip of an irrational mortgage market that has been spooked by recent events and has spun out of control,” he says. “The UK’s model has worked well in the past, but the health of the sector as a whole depends on high levels of employment, low inflation and the cost of living coming down. We just hope the UK’s economy is in for soft landing rather than a recession.”

However Vicky Redwood, an economist at Capital Economics is not optimistic. “Lenders are still struggling for funding, and will continue to pass on the cost to borrowers in the form of increased rates. We are yet to see the full impact of the credit crunch on the wider economy and unfortunately have not seen the worst of it.”

She believes that house prices have got much further to fall: “House prices will fall by a further 15-20% this year, and further falls throughout 2009-10 – meaning a total house price fall of at least 35%.”

When the credit crunch set in last year, few could have predicted the impact it would have on the UK. However one thing appears to be clear - the credit crunch is here to stay for now, and it unlikely to all be over by Christmas.

 

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