Are UK rate hikes starting to bite?

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The dominoes continue to topple as the credit crunch picks up speed.

Here in the UK, retail sales are finally starting to show signs of slowing last month saw annual sales rise at the slowest pace since November.

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Meanwhile, in the US, a mainstream mortgage lender has just gone to the wall. So much for the subprime crisis being contained.

Now that the bad debt monster is rising out of the slums and the trailer parks and into the world of white picket fences and middle-class America, the big question on everyone's mind is - who's next?

The wet weather took its toll on the UK's high street in July. Same-store sales rose by just 1.2% on an annual basis, the smallest increase since November, according to the British Retail Consortium, "despite heavy discounting". That's compared to a 3% rise in June.

Sales of both food and clothing suffered outright sales falls, while book sales were saved by the latest Harry Potter hitting the shelves. Retail sales have slowed in three of the past four months, suggesting that interest rate hikes, as well as the weather, might be starting to have some impact on UK consumers.

Meanwhile, in the US, American Home Mortgage (AHM) has filed for Chapter 11 bankruptcy protection, after laying off a full 90% of its workforce 7,400 people in total. The group cited a "sudden adverse impact on liquidity from the extraordinary disruptions now occurring in the secondary mortgage and real estate markets."

As an aside, we would perhaps take issue with the phrase "extraordinary disruptions." There's nothing particularly extraordinary about them. In fact, they are the completely predictable result of the "extraordinary" lending policies of recent years which have seen entirely uncreditworthy people given money to buy houses that they can't afford.

At the end of March, the company America's tenth biggest mortgage lender - had total debts of $4bn. Investment banks Deutsche Bank and JP Morgan are among its biggest creditors.

The big worry is that AHM wasn't a subprime lender. Its customers were 'prime' and 'near prime'. So all the predictions by Hank Paulson and Ben Bernanke that subprime would remain contained have already been shown up to be the over-optimistic gobbets of wishful thinking that they always were.

Charles Whalen of the Institutional Risk Analytics consultancy told The Times to expect more casualties: "At the moment, we are hearing silence. There are plenty of banks out there who had the same asset allocation as Bear Stearns. So where are all the others? People are only just beginning to 'fess up to their exposure."

As Whalen points out, this is only the beginning. Credit Suisse reckons at least another 1.5m people are likely to default on their home loans as a swathe of mortgages see their interest rates adjusted upwards over the next 18 months.

There's a long way to go before all of this plays out and it will be interesting to see how the Federal Reserve spins this one when it meets today to decide on the future of US interest rates. Merrill Lynch reckons that the Fed will have to start cutting rates soon, taking them down to 3.75% by the middle of next year.

But with the dollar already looking extremely sickly, the Fed is walking a very thin tightrope. We suspect Mr Bernanke will be much more careful about hinting at rate cuts than Wall Street is hoping he will be. After all, a race by foreign lenders to bale out of the dollar could make the current volatility look positively peaceful by contrast.

Turning to the wider markets

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Despite a strong opening on Wall Street, London stocks ended a day of light trading in the red yesterday. The blue-chip FTSE 100 index was 35 points lower, at 6,189, as mining stocks - most notably Lonmin - weighed heavily. However, insurer Standard Life topped the FTSE leaders with gains of over 3% on reports that it is to revive its bid for peer Resolution. For a full market report, see: London market close.

On the Continent, the Paris CAC-40 fell 64 points to end the day at 5,532 as credit concerns hit construction companies including Lafarge and Saint Gobain. In Frankfurt, the leading DAX-30 index added 8 points to close at 7,444 as M&A talk in the sector boosted chemical stocks.

On Wall Street, the Dow Jones had its best day since 2003 as investors piled back into financials including American International and Citigroup. The index closed 286 points higher, at 13,468, recovering all of Friday's losses. The tech-heavy Nasdaq added 36 points to end the day at 2,547. And the broader S&P 500 was 34 points higher, at 1,467.

In Asia, the Nikkei was 7 points higher, at 16,921 and the Hong Kong Hang Seng was down 28 points at 21,907.

Having tumbled over 5% yesterday, crude oil had fallen a further percentage point to $71.33 this morning. In London, Brent spot was down to $71.48.

Spot gold had fallen to $670.65, down from $671.50 in New York late last night. Silver, however, had risen to $12.98/oz.

In the currency markets, sterling fell to a two-month low against the euro this morning and was last trading at 1.4678. The pound was also lower against the dollar, at 2.0269. Meanwhile, the dollar was at 0.7239 against the euro and 118.66 against the Japanese yen.

And in London this morning, miner Xstrata announced a $1bn - or 105 rand-a-share - offer for South African Eland Platinum Holdings Ltd. Xstrata also disclosed a 47% increase in first-half net profit, in line with analysts' forecasts. Shares in the London-listed mining stock were up by as much as 4 pence in early trading.

And our two recommended articles for today...

Two reasons to be cheerful during market volatility

- According to Charles Stanley's Jeremy Batstone-Carr, the outlook isn't quite so gloomy as recent market action would suggest. In fact, investors should consider picking up favoured stocks at reduced prices. For his discussion of the two essential points investors must bear in mind during the current bout of volatility, click here: Two reasons to be cheerful during market volatility

What does the credit crunch mean for commodities?

- The Onassis Management team explain how the recent upset in the credit markets has affected their commodities investment strategy. To find out what they think commodities investors should do in the event that markets fall further, read: What does the credit crunch mean for commodities?