Europe Economy

Credit Crunch Makes Rate Cut More Likely: BoE's King



Tighter lending conditions have made the Bank of England more inclined to cut interest rates as the global credit crunch enters a new and difficult phase, Mervyn King, the central bank's governor, said on Wednesday.

Sterling weakened after BoE Monetary Policy Committee members also highlighted downside risks to the pound, already down about 10 percent on the year on a trade-weighted basis.

"The financial crisis has moved into a new and difficult phase. Across the world, confidence in financial markets is fragile," King told a parliamentary committee.

Interbank lending rates rose even further on Wednesday as banks, fearful of each others' exposure to plunging U.S. real estate prices, remain very wary of lending to each other, exacerbating fears the credit crunch will trigger a sharp economic downturn right across the world.

Asked if tightening lending conditions in financial markets had made British policymakers more predisposed to chopping its benchmark interest rate, King said, "Yes."

He noted that mortgage rates being charged by banks now were about the same as in August despite the BoE having cut interest rates by 50 basis points to 5.25 percent since then.

Investors immediately priced in a greater chance of the BoE cutting again next month. A Reuters poll of analysts last week showed a majority thought a May move was more likely.

"We now expect the Bank of England to trim interest rates by a further 25 basis points to 5 percent in April rather than May," said Howard Archer, economist at Global Insight.

While slower growth was clearly a worry, King also said he expected UK inflation, already running above the central bank's 2 percent target, to rise even further and hit around 3 percent because of soaring utility bills.

Policymakers have been keen to stress this year that higher inflation must not get entrenched in the public mindset and interest rate policy will have to reflect that risk as well as manage the slowing in the global economy.

"The MPC can have little effect on the short-term path of inflation," King said. "What is crucial is that the pick-up proves to be temporary."

Ready to Act

The biggest risk for most of the BoE policymakers appearing alongside King, however, was the seven-month old financial crisis which still appears to have no end in sight.

Banks, still nursing multi-billion dollar losses, have been furiously lobbying the BoE to do more to take the pressure off them by throwing more money into the financial system.

One idea mooted after their top executives met with King last week has been for the BoE to accept lower quality collateral in exchange for cash or government bonds.

Admitting that last month's coordinated central bank action to shore up confidence had failed, King said the BoE stood ready to provide whatever liquidity was needed and was still working on a longer-term solution to the crisis in conjunction with the banks.

"It is too soon to say where these discussions will lead," he said. But he was clear that the cost of any panacea would have to be borne by shareholders of the banks themselves and not the British taxpayer.

"I want to assure you that the Bank will provide the liquidity assistance that the system needs in order to restore confidence," King said. "Such lending can be only a temporary measure, but it can be a useful bridge to a longer-term solution."