Expectations of an interest rate cut rose yesterday as the credit crunch forced banks to rein in their lending and financial turmoil threatened to hit the wider economy.
The Bank of England's survey of credit conditions showed that lenders had unexpectedly made big cuts in secured lending to households in the fourth quarter of 2007. With further cuts expected, the banks' actions could deal a further blow to the already weakening housing market.
Banks also cut back on credit for unsecured household borrowing and corporate loans, putting pressure on flagging consumer spending and companies' ability to invest for the future.
The pain is not set to end soon. The survey predicted that banks would tighten all lending still further in the first quarter of this year.
Banks have reined in their lending as they have conserved cash to deal with the credit crunch. The Bank of England is worried the squeeze in financial markets will spill into the real economy if banks withdraw credit for consumer spending and corporate investment. The central bank's Monetary Policy Committee cut rates by a quarter point last month for the first time in two years in an attempt to ward off a recession.
Most economists expect the committee to keep rates on hold next week before cutting in February. But the news of banks' reluctance to lend increased the chances of an imminent cut to try to prevent a recession.
Howard Archer, the chief UK and European economist at Global Insight, said: "The significant tightening of credit conditions for both households and corporates in the fourth quarter of 2007, and the expected continuation of these trends in the first quarter of 2008, increases pressure on the Bank of England to trim interest rates again. It is highly possible that the Bank of England could cut interest rates from 5.5 per cent to 5.25 per cent as soon as next Thursday."
Lenders cut secured household credit because it was harder to get the loans off their balance sheets and conditions for raising fresh capital were tighter, the Bank of England said. Demand for prime mortgage loans was lower than expected but demand from buy-to-let landlords and people with poor credit records increased after some lenders cut back their activities.
Banks' lending to big companies dropped sharply because of scarce funding and concerns about the economy. There was a "material" tightening of lending for the troubled commercial property sector.
The news hit the pound, which dropped to a new low against the euro and also fell against the dollar and the yen. Gloomy trading updates from DSG International, the owner of Dixons, and Next fuelled fears about a major slowdown in high-street spending as economic uncertainty and higher household costs force indebted consumers to tighten their belts.
The survey was concluded on 12 December, just as the Bank of England and other major central banks announced coordinated action to inject liquidity into the financial system to combat a freeze in inter-bank lending. Inter-bank rates continued to fall yesterday, with the three-month sterling Libor rate dropping to 5.89 per cent, down from a 6.9 per cent peak on 11 September. But Libor is still well above the base rate. With markets expecting a series of rate cuts in the coming months, Libor would normally be closer to or even below the base rate.
"The falling back of the Libor rate slightly eases pres sure for an immediate cut, but there will be more uncertainty and hiccups along the way," Mr Archer said.Reuse content