Home buyers 'will find it even harder to get a mortgage' in next few months

The Council of Mortgage Lenders issued the warning as it released figures showing mortgage lending had dropped almost 30 per cent on the same period last year.

Bob Pannell, CML head of research, said: 'While there was a small month-on-month increase in activity, it represented a notable decline from a year ago.

'This continues the weaker picture seen in June and points towards the more subdued levels of lending we are likely to see in the second half of 2008.'

The figures came as market analyst
Datamonitor said it expected the UK mortgage market to shrink by nearly 20 per cent this year.

The group said the outlook for the market was bleak, with the ongoing problems caused by the credit crunch leading to fewer lenders operating, a shrinking number of products, higher prices and more consumers being refused credit.

The news comes after it was revealed that the Bank of England considered both cutting and raising interest rates this month - then decided to leave them unchanged.

Monetary Policy Committee (MPC) member Tim Besley voted to increase the cost of borrowing by 0.25 per cent to 5.25 per cent, minutes of this month's meeting showed.

It was the second month in a row he argued for a rate hike.

But seven members chose to keep rate steady at 5per cent, saying that  despite the fact that the economic outlook had continued to worsen, it was the best policy to bring inflation back to its 2 per cent target.

The other committee member, David Blanchflower, voted for a rate cut.

The minutes said members were worried an unexpected rate rise might adversely affect business and consumer confidence, adding to downside pressures on activity and causing inflation to undershoot its target over the medium term.

Although rates could be cut be later, the downturn would be 'unnecessarily deep, adding to the volatility in the economy'.

In pressing for a rate cut, Professor Blanchflower argued the inflation risk was offset by the impact of a rapidly slowing economy.

The majority of members said the main risk of an immediate rate cut was that it could suggest the committee was more concerned about sustaining output growth than about returning inflation to the 2 per cent target.

Inflation hit 4.4 per cent in August and is expected to reach 5 per cent before the year end thanks to soaring food and energy prices.

Bank of England governor Mervyn King also warned last week that the UK economy faced at least one quarter of negative growth.

Jonathan Loynes, of Capital Economics, said the minutes showed the interest rate debate remained finely balanced.

He added: 'There is little here to suggest that other members are about to join Blanchflower in voting for a cut in the very near future.

'Nonetheless, with inflation close to a peak and the economy heading towards recession, we still think rates could be falling by the year end and will eventually drop much further than the markets expect.'

James Knightley, of ING Financial Markets, said he forecast interest rates of 3.5 per cent by the third quarter of next year.