City braced for early rate cut

City braced for early rate cut

Mervyn King, the Bank's governor, said the financial crisis that began last summer had entered a "new and different phase", adding that across the world confidence in markets was fragile.

The governor said Threadneedle Street was in discussions with Britain's high street banks to find a long-term solution to the eight-month-old financial crisis but warned that there could be no blank cheque from the taxpayer.

King's remarks to the Commons Treasury committee came as the interbank cost of borrowing rose in the City for the 12th successive trading day. London interbank offered rates (Libor) for sterling funds lent over three months edged up from 5.995% on Tuesday to 6% today, their highest since late December.

Asked if tighter lending conditions were making interest rate cuts more likely, King replied "yes".

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

"Further out, we expect interest rates to fall to 4.5% by the end of the year and to 4% in the first half of 2009, as we believe that extended below-trend growth will eventually significantly undermine companies' pricing power and limit wage growth, thereby diluting underlying.....continued below

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Sterling also fell after the governor and four other members of the Bank's monetary policy committee gave evidence to MPs. Charlie Bean, Threadneedle Street's chief economist, said the size of Britain's current account deficit meant the risks to the pound were "on the downside" even after its recent decline.

One of the other members of the committee, David Blanchflower, said he was concerned that "something horrible" might be about to afflict the economy and said his concern explained why he had often been a lone voice favouring cheaper borrowing. "I think it is appropriate to take out some insurance and stay ahead of the curve," Blanchflower said.

The governor said that the MPC had to balance the risks that a sharper than expected slow-down in growth caused by the credit crunch would lead to inflation undershooting its 2% target against the possibility that a higher cost of living in the short term would become embedded and trigger a wage-price spiral.

Although the economy would slow down in 2008 and 2009, King said it would be wrong to "confuse that with a depression or a slump". He said the situations were "a million miles apart".

King added, however, that the housing market would remain in the doldrums for several years. "I would be surprised if in a few years' time house prices were markedly above where they are now. I see broadly stable house prices over the next few years."

King said that the two quarter-point cuts in bank rate in recent months had offset higher mortgage rates being charged by lenders, but added: "The heart of the problem is not in the real economy, it is in the financial sector itself."