The summer of 2008 is shaping up to be a difficult one. The cost of food is soaring, petrol prices are at a 20-year high, and with the Coutts Wealth Inflation Index showing a 9.5% rate of inflation for luxury goods, the credit crunch continues to bite, raising the cost of borrowing, undermining confidence in the housing market and wreaking havoc on global financial markets.

How long the crunch continues is now the key question. "A credit crunch has a number of phases," says Carl Astorri, head of investment strategy at Coutts. "Its primary effect is on the banks. You then have a secondary effect on money markets, and then there is an impact on the broader economy. Because the banks have had a part of their capital destroyed, they start to lend less because their appetite for risk is reduced. There is less credit available for companies and households, and in addition, money costs more." As a result, economic growth slows.

The Bank of England’s financial stability report published on May 1 stated that the credit markets "are likely to overstate significantly the losses that will ultimately be felt by the financial system and the economy as a whole", and that would "exaggerate to an even greater extent the potential damage to the real economy". Put simply, fears over the damage caused by the credit crunch could become a self-fulfilling prophecy.

So what does all this mean for UK savers, borrowers and homeowners?

Borrowers

The markets for mortgages and consumer credit have been transformed over the past few months. In the month of March alone the number of mortgage products available fell from 7,726 to 5,700. A year ago, there were more than 9,000 products available. Lending criteria have also been tightened up: according to one survey there are now just five lenders who offer 100 per cent loans, while the availability of 90 and 95 per cent deals has also plummeted.

"Savills recently revised its forecast for the property market: having previously forecast an increase in prices of 1 per cent in 2008, the estate agent now says it expects prices to fall by 4 per cent in 2008"

The contraction of the mortgage market is not just a problem for those wanting to purchase homes. Those coming to the end of their fixed rate deals are also confronted with a far poorer choice. They also face the prospect of having to pay higher monthly repayments. Despite the fact that the Bank of England has cut the base rate of interest three times in the past five months, taking it from 5.75 to 5 per cent, mortgage rates have not fallen at the same rate. This is because Libor (the London Inter-Bank Offered Rate), the rate at which banks lend to each other, has remained high: three-month sterling Libor was 5.87 per cent at the end of April.

Borrowers at the top end of the market are also finding that conditions have worsened. While there was a time at which lenders would aggressively compete to lend money to richer individuals, because cash is so expensive in the current climate, many banks and building societies are now increasingly reluctant to lend larger amounts. But while traditional lenders have withdrawn from the million-plus mortgage market, the likes of Coutts have stepped into the breach. "It is well worth looking at private banks if you wish to borrow a large amount," says Melanie Bien of Savills Private Finance, the mortgage broker. "Private banks have been raising their mortgage rates more slowly than many of the high street players."

The credit crunch has provided a double whammy for homeowners with mortgages: not only have they seen the cost of borrowing rise, but problems in the credit market have led to falls in house prices. After more than a decade of sometimes spectacular house price growth, property prices have finally peaked and are now starting to fall. Halifax’s house price index showed a fall of 2.5 per cent in March, its sharpest monthly decline since September 1992, while Nationwide’s figures show that house prices recorded their first annual fall – of 1 per cent – for 12 years.

While the state of the economy and employment rates will play a large part in determining how far and how fast house prices fall, the credit crunch will have a significant impact, too. Savills recently revised its forecast for the property market: having previously forecast an increase in prices of 1 per cent in 2008, the estate agent now says it expects prices to fall by 4 per cent in 2008 and 2 per cent in 2009. However, this forecast is based on the assumption that "the impact of the credit crisis is primarily restricted to the financial sector". Should the credit crunch make its effects felt more widely, Savills says prices could fall by 10 per cent this year and 15 per cent in 2009.

"However, while the credit crunch may be good news for savers, it has not been so kind to investors with money in the stock market. Bad news stories from the financial sector, the troubles of the likes of Northern Rock in the UK and Bear Stearns in the United States, have meant a prolonged period of stock market volatility."

While this is clearly bad news for those of us who own homes, the credit crunch could actually turn out to be a positive development for potential first time buyers. "If property prices were to fall by 15 per cent in the next 18 months, then those who are itching to get their foot on the housing ladder could benefit from a double whammy of high saving rates and the falling cost of that elusive first property," says Andrew Hagger of Moneyfacts.

Prices at the top end of the housing market are proving more resilient than the mainstream, largely because buyers of multi-million pound properties are less likely to borrow heavily in order to fund their purchases. In central London, the volume of transactions has fallen heavily: the number of houses changing hands in the first quarter of this year was down almost 50 per cent on the same period in 2007. However, prices have continued to rise. Figures from the Land Registry, which admittedly lag the market because they reflect completed transactions, show that property prices in prime central London were up 17 per cent in the year to March 2008.

The prices of prime property in the countryside are also holding up well. Property search agents say that competition for houses in the £5 million-plus range remains fierce due to the chronic lack of supply. Landed properties – farms, decent estates and houses with more than 50 acres – are particularly in demand.

Along with prospective first time buyers, savers are the other group benefiting from problems within the credit market. Coutts currently offers rates of up to 4.8 per cent on its Private Reserve Account, while its Coutts Sterling Liquidity Fund offers around 6 per cent. Business clients can get rates of up to 2.75 per cent.

However, while the credit crunch may be good news for savers, it has not been so kind to investors with money in the stock market. Bad news stories from the financial sector, the troubles of the likes of Northern Rock in the UK and Bear Stearns in the United States, have meant a prolonged period of stock market volatility. Since its high of 6,732 last summer the FTSE-100 has fallen by around 10 per cent. However, prospects for equities, both in the UK and elsewhere, are positive, Astorri says. "We have already gone through the stagflation part of the economic cycle, when growth falls and inflation rises," he explains. "We have now transitioned into the recession phase, which is actually a better time for risk assets like equities." While it might sound counter-intuitive to buy stocks during a recession, this is in fact a good time to buy; first because valuations are relatively low – they have in fact been attractive for some time – and second because as we move through the recessionary phase of the cycle, confidence returns to the markets and stocks will start to rise.

By Paula Hawkins