Bank of England - Credit Crunch Overplayed?

3 May 2008

In its latest Financial Stability Report, the Bank of England says the economic fallout from the credit crunch may not end up being as bad as originally feared. Current estimates suggest subprime mortgage (and related) losses may be as high as £200 billion. The Bank reckons they could be closer to £85 billion.

As the Bank puts it: "Prices in some credit markets are now likely to overstate the losses that will ultimately be felt by the financial system and the economy as a whole, as they appear to include large discounts for illiquidity and uncertainty. Conditions should improve as market participants recognise that some assets look cheap relative to credit fundamentals." But therein lies the problem, the unfreezing of markets could take longer precisely because banks aren't taking this on board.

Worth pointing out too is that if the credit crunch ends up being less protracted than forecast this will have major implications for interest rates - not least the even more remote prospect that the Bank of England will sanction rate cuts on the scale already seen in the United States. BoE Governor, Mervyn King, has already stated as much, telling lawmakers recently that a slowdown in economic growth wouldn't necessarily be a 'disaster'.

Meanwhile, John Gieve, Deputy Governor for Financial Stability, says that while the unavoidable correction after the credit boom is proving protracted and difficult, the pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals. Hence, while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months.

Source: Moneyextra