The decline in mortgage interest rates to a 17-month low in October provided a temporary boost to refinancing activity, says Capital Economics in a client note.

Mortgage applications for home purchase were still languishing in the doldrums, but signs that credit conditions are loosening should help demand recover over the next year.

The Mortgage Bankers Association’s measure of 30-year mortgage interest rates fell to 4.19% in October, the lowest level since early last year.

In the final week of the month, during which the Fed wound up its purchases under QE3, mortgage rates averaged 4.17%.

“We never expected mortgage rates to spike in the immediate aftermath of the end of asset purchases – after all, the completion of previous rounds of quantitative easing actually saw Treasury yields and mortgage rates fall back. Nevertheless, the approach of Fed tightening should put upward pressure on mortgage rates from here,” says Paul Diggle, property economist for Capital Economics. ?”That means that, although the latest decline in mortgage rates has provided a small boost to refinancing activity, a sustained surge is not on the cards.”

Mortgage applications for refinancing rose by 18.8% month-over-month in October, to an eight-month high.

But the relationship in the chart below, Diggle says, suggests that refinancing activity cannot increase much further without a sustained decline in mortgage rates, which is not on the cards.

Click to enlarge

“In any case, the more important indicator of active housing market demand is mortgage applications for home purchase, and they ticked 0.5% m/m lower in October. That sits comfortably with the slight weakening in mortgage demand reported in the Fed’s Q4 Senior Loan Officer Survey, released earlier this week. In that survey, a marginal net balance of lenders reported a decline in prime mortgage demand relative to the previous quarter,” Diggle says.

Yet, while mortgage demand is flat lining, mortgage availability appears to be improving.

“Lenders responding to the Senior Loan Officer Survey reported loosening standards on mortgage credit for the second consecutive quarter. Alongside strong job growth and signs that income growth is finally picking up, there are grounds to think that mortgage demand will rise from here,” he says.