Bill Jamieson: Corporate Britain is feeling lending pain

SO FAR, little has been heard of the growing apprehension within the corporate sector about the effects of the credit crunch. I suspect that this will change soon.

Once Prime Minister Gordon Brown has put together a scheme to exchange bank mortgage-backed assets for new Government bonds it can only be a matter of time before companies great and small beat a path to his door. Should other forms of bank lending not qualify for this favourable treatment? Or is this to be a private party, limited to those sectors of the economy where some political advantage may be obtained?

I ask because the latest Bank of England Credit Conditions Survey shows that lenders have reduced overall credit availability not only to mortgage borrowers but also to corporates over the past three months. Loan approval rates have fallen, particularly for large private non-financial corporations. And overall credit availability is expected to be reduced again over the next three months, with approval rates expected to fall further. Sounds worrisomely familiar.

Even more eerily familiar is this: over the three months to mid-March, lenders reported that they had increased spreads on new lending to private non-financial companies. Lenders also reported higher commissions and fees. Moreover, they expect a further widening of spreads and rises in fees over the next three months.

As bank lending to the business sector is a critical conduit to the heart of the economy, I can only advise business borrowers and their agents to start forming a queue in Downing Street this weekend, and not necessarily an orderly one.

Now of course lending to the UK's housing market is an especially large and sensitive jugular vein. Indeed, the bulk of bank lending to households – about 90% – is secured on property. And the bulk of the tightening in the terms and availability of credit to households will therefore fall on mortgage lending.

This we are already seeing. Mortgage products have been withdrawn, rates and fees have been increased and the number of new mortgages approved has slumped some 40% from a year ago. Little wonder there is a state of near panic about the implications for house prices.

We are now on a precipice, or as Charles Bean, the Bank of England's chief economist more modestly described it in an incisive speech last Thursday evening, walking on a tightrope for monetary policy.

Look down the ravine on one side and a self-feeding depression looms. If the credit crunch turns out to have a severe impact on growth and opens up spare capacity, inflation will not only fall back but could, he warns, undershoot the target in the medium term. "And there is the possibility that an adverse feedback loop might develop in which tighter credit depresses growth and puts downward pressure on asset prices, leading to a further deterioration in banks' balance sheets and a subsequent further round of credit tightening. Were that to develop, then it could prove extremely costly."

But look down the ravine on the other side and the view is no better. Continuing rises in global energy and food prices push up UK inflation and may start to generate second-round effects on pay and other prices, leading to persistent higher inflation. And that could trigger a 'de-anchoring' of inflation expectations. The inflation balloon goes up. "Again, if that were to happen, it could also prove extremely costly."

Hence the policy bind that the MPC is in when it comes to cutting interest rates. All this looks dire, and the same bleak view pervades the Ernst & Young Item Club forecast due out tomorrow. This sees GDP growth falling to 1.5% in 2009 and a fall in house prices of 10%. Economist Peter Spencer says this risks "further depressing people's willingness and ability to borrow and spend… The abruptness of this change in direction could make it a very rough ride."

But there are chinks of light offered by Charles Bean in this gloom. First, it is by no means certain that a significant fall in house prices would also generate a sharp slowing in consumer spending. According to an annual survey carried out by the Bank, only 5% of borrowers have less than 20% equity in their home.

He also notes that the past correlation between house price movements and consumer spending disappeared after the start of this decade as house prices came to be driven by factors other than changes in expectations about incomes.

And there is a gleam of hope for UK exporters from the 12% fall in the effective exchange rate for sterling since August. Broadly speaking, the fall is of the same order as the depreciation after Britain's exit from the ERM in 1992. If the same rule of thumb applies – a one percentage point fall in the exchange rate has the same effect on output as a 0.25% cut in interest rates – UK exporters have now been delivered a cut in interest rates equivalent to three percentage points.

On the charge that the Bank of England's one monetary policy tool – interest rates – is effectively broken and that changes in official rates in today's distressed environment make little to no difference, he is dismissive. The right comparison to make, he says, is with what would have happened had the Bank rate not been cut: rates paid by households and businesses would have been even higher. Rate cuts should also improve bank balance sheets and in time increase the funds available for lending. And they have certainly brought down sterling, which should help our competitiveness.

Prospects for immediate relief on the precipice now hang on a deal being struck by the banks, the Bank of England and the Government to unfreeze markets and improve the flow of mortgage finance. But that, I suspect, will bring other types of distressed lending and borrowing to the Prime Minister's door.