It’s a tough time to be a borrower at the moment. Until relatively recently, credit was cheap and easily available, and mortgage lenders were all but fighting each other to win business.

However, the boot is now on the other foot. Since the credit crunch took hold last year, it has become increasingly difficult and expensive to borrow; banks and building societies have tightened their lending criteria and raised their rates, and the availability of mortgages has contracted sharply.

In its recent Credit Conditions Survey, the Bank of England has warned not only of a decline in the availability of mortgages, but also of a likely increase in the proportion of defaults by struggling homeowners. The heightened risk that some borrowers might default on their mortgage payments has spurred many lenders to make their lending criteria more restrictive, reducing the opportunity for higher-risk applicants to borrow money.

Meanwhile, new mortgage approvals declined from 74,000 to 73,000 during February, a drop that took the figures close to their 13-year low. Steepening mortgage rates are deterring potential first-time buyers from entering the housing market. However, demand is still relatively high in certain areas – the fixed-rate deals of over a million borrowers will expire this year, forcing them to look for new deals. Meanwhile, following the collapse of Northern Rock and its subsequent nationalisation, many of its customers are looking to move their mortgages to an alternative lender.

Several lenders have reduced access to their mortgages; and attractive deals have become increasingly rare, so any company offering competitive rates has been swamped with potential customers. First Direct has temporarily stopped offering mortgages to new customers while it catches up with the paperwork, and Abbey has now withdrawn the last straightforward 100% deal ‘in order to maintain high service levels’.

The Bank of England has cut interest rates to 5.5%, and rates are widely expected to fall further over coming months. Despite this, many lenders have actually raised their mortgage rates; the global credit crunch has deterred banks and building societies from lending to one another, so the companies are working to protect their profit margins. In the long term, banks and building societies are likely to regard the current situation as an opportunity to clean up their lending books and emerge in better shape; in the immediate future, both borrowers and lenders are likely to feel the pain.

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Prospects for US interest rates remain firmly in the spotlight. An unscheduled and drastic cut in US rates in January was swiftly followed by an additional and substantial reduction at the Federal Reserve’s scheduled January meeting. In March, another 0.75% cut was announced as markets reacted badly to the takeover of Bear Stearns by JP Morgan Chase following a US$30 billion Federal Reserve (Fed) aid package. US interest rates are now just 2.25%.

Nevertheless, investors remain nervous and the Fed has been criticised for what some economists view as a short-term approach to the deeper-seated problem. The economic outlook continues to deteriorate following the collapse of the domestic housing market, the global credit crunch, and soaring fuel prices.

US interest rates have now undergone six cuts since September 2007 – so where do we go from here? The Fed has cut its forecast for economic growth in the US and appears to anticipate a greater-than-expected rise in unemployment over the course of 2008. Meanwhile, inflation is forecast to reach as high as 2.4% in 2008, driven by surging prices. The current scenario has raised the unwelcome spectre of stagflation, in which prices continue to rise while growth stagnates.

Despite the risks to inflation, the deteriorating environment had boosted expectations of interest-rate cuts in 2008, and Fed chairman Ben Bernanke has favoured monetary easing to stave off a recession in the US and ease the effects of the credit crunch. Lower interest rates in the US will have a direct influence on the global economy: the US economy is still the largest in the world and an economic slowdown in the US would have a negative effect on economic growth in many countries in Europe and Asia, where exports to the US can make up a significant proportion of revenue.

Any recovery in US demand would be well received, but lower interest rates do undermine the already weak US dollar, providing additional impetus for the booming oil price, which could stoke inflationary pressures. Where the Fed now goes from here remains to be seen, but policymakers are having to perform a delicate balancing act in trying to ensure the economy does not stall, at the same time as keeping inflation in check.

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The price of gold has reached new highs recently, boosted by ongoing speculation over further cuts in US interest rates. Many investors view gold not only as a “safe haven” in times of stock-market turmoil, but also as a way to mitigate the effects of rising inflation and a weak US dollar.

Growing fears of a recession in the US have led policymakers to reduce US interest rates in order to stimulate economic growth. However, these lower interest rates could help to stoke inflation and exacerbate the decline of the faltering US dollar. A weak dollar helps to drive the gold price higher: like oil, gold is priced in US dollars, so dollar weakness makes gold cheaper for investors buying in other currencies.

The effects of increased demand for gold have been compounded by a growing shortage of supply. Electrical power cuts have halted production at some of South Africa’s most important mines when the South African government was forced to take the radical decision to ration electrical power. This, combined with fears that gold production could be halted for several weeks, helped to boost gold prices to their recent highs.

A good diversifier

Volatile market conditions, coupled with the fallout from the global credit crunch and growing fears over prospects for the global economy, have led many investors to add gold to their investment portfolios. However, gold does not have to be viewed purely as a safe haven; for many investors, it has become an important, long-term element within a diversified investment portfolio. It is vital to acknowledge that gold is not a risk-free investment: its price is volatile and can fluctuate rapidly. Nevertheless, gold’s low correlation with the equity market and bond market make it a useful means of diversification within an investment portfolio.

Some investors favour owning gold directly, which can be bought in the shape of gold coins and bullion bars; others prefer to gain exposure via exchange-traded funds: investment funds that track the price of gold. A lower-risk approach – in relative terms – might be to opt for a diversified commodities or natural resources fund, thereby spreading an investment over a wider area than just gold.

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