U.K. Mortgage Bond Market May Stay Shut Through 2009, BOE Told

March 16 (Bloomberg) -- U.K. residential mortgage-backed bond markets may stay shut throughout the rest of this year as banks nurse losses from the financial crisis, according to the Bank of England’s contacts.

“Overall liquidity conditions have yet to normalize to any significant degree,” the central bank said in its quarterly bulletin today. “Residential mortgage-backed securities (RMBS) markets remained effectively closed, at least for publicly issued securities. In general, contacts did not expect a sustained improvement in market conditions during 2009.”

Average asking prices for a home dropped 9 percent this month from a year earlier as buyers struggled to obtain home loans, Rightmove Plc said today. The British economy is in the throes of its worst contraction for three decades, threatening to exacerbate losses at banks stung by the financial crisis.

The central bank said in its report that credit costs rose last month as institutions became more reluctant to lend to each other. While the three-month London Interbank Offered Rate has fallen more than 4.4 percentage points since last year’s peak, the Libor-OIS spread, a gauge of banks’ reluctance to lend, widened to a two-month high on March 11.

“Contacts cite ongoing balance sheet constraints on financial institutions as an important factor in continued pricing anomalies in various asset markets,” the bank said.

The outstanding balance of British residential mortgage- backed securities was the world’s second-biggest as of the third quarter of 2008, totaling 407 billion euros ($525 billion). That’s still a 10th of equivalent outstanding U.S. securities.

Toxic Assets

Prime Minister Gordon Brown has taken controlling stakes in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc and agreed to insure 585 billion pounds ($816 billion) of toxic assets, in return for pledges that they will lend more.

Rightmove, Britain’s biggest property Web site, said asking prices for homes fell 9 percent from a year earlier, close to the pace of February. On the month, prices rose 0.9 percent to an average of 218,081 pounds, the report showed.

The Bank of England cut the benchmark interest rate to 0.5 percent on March 5, and started printing money to buy gilts and other assets to revive the economy and prevent deflation. The bank will spend 2 billion pounds on government bonds today and a total of 5 billion pounds this week.

The central bank’s forecasts show economic growth won’t resume until the second quarter of next year, while inflation will slow to 0.3 percent in early 2011, below the bank’s 2 percent goal.

Policy Action

Policy makers “will take the necessary steps to bring inflation back to target by making changes to monetary policy so that any deviation from target is short-lived and less costly,” according to a separate article in the bulletin by Charlotta Groth and Peter Westaway, both officials at the bank.

The central bank’s economic forecasts are consistent with the “configuration of falling asset prices and depressed economic conditions in the face of an adverse demand shock” in an environment of debt deflation, the article said. Uncertainty about how the strength of these effects form part of the bank’s uncertainty about how bad things will get, the bulletin said.

A situation of deflation where interest rates are at zero also poses a risk to the economy by eliminating one of the central bank’s tools for stoking growth, the economists said.

“If policy responds sufficiently promptly and decisively, employing the full range of conventional and unconventional monetary policy instruments, deflationary episodes should be short-lived,” Groth and Westaway wrote.