The Governor of the Bank of England yesterday pledged to continue supporting liquidity-starved banks, but stopped short of promising to buy worthless mortgage-backed securities.
Mervyn King told the Treasury Select Committee that following last week's summit meeting with leading banks, he was in continuing talks with the sector over finding a "longer-term solution" to the credit crisis.
Mr King promised that the central bank would "provide the liquidity assistance that the system needs in order to restore confidence". However, while the Governor confirmed that in December, January and March the Bank had broadened the range of collateral it accepted on repurchase agreements to include certain residential mortgage-backed securities, he denied any plans to begin buying unwanted mortgage-backed securities.
Such a move would be hugely controversial, with critics claiming that it would amount to taxpayers bailing out the City. "We are taking some mortgage securities as collateral on repo agreements," he said. "That is very different from offering to buy all mortgage-backed securities."
Last week, the Bank again pumped billions of pounds into the money markets in addition to the weekly funds offered to commercial banks. However, the extra liquidity has failed to bring down the cost of borrowing, with the Libor rate at which banks lend to each other touching 6 per cent yesterday.
Mr King said the offer of funding assistance was only a temporary measure, adding "we are discussing with the banks how a longer-term resolution of the problem might be reached".
He warned it was too soon to say where the discussions would lead, but the Bank later refused to give any further details on the talks.
The financial crisis has moved into a new and different phase worldwide, Mr King added. "Across the world confidence in financial markets is fragile," he warned. "It stems from an 'overhang' on banks' balance sheets of assets in which markets have closed. These assets cannot now be sold or used to secure funding in the market – they are difficult to finance. That has created uncertainty about the strength of banks' financial positions."
In addition to fresh liquidity, MPs on the committee were also told that the further deterioration of the markets meant the chances of an interest rate cut next month had increased.
Mr King said that the weakening market conditions meant the Monetary Policy Committee, which sets the UK's interest rates, was more likely to consider a cut. Last week, the MPC minutes for March's meeting revealed that the Governor's deputy, Sir John Gieve, had voted to cut rates. The vote went eight to two to remain at 5.25 per cent.
Sterling fell against the euro yesterday in the wake of bearish sentiment on the short-term prospects for the currency from the central bank.
Charles Bean, the chief economist to the Bank of England, told the Treasury Select Committee that regarding the currency "the risks are balanced on the downside", sending the pound lower in the afternoon.
Andrew Sentance, another member of the MPC, added that he expected consumer spending to weaken in the next few months. However he called outright recession a "remote risk for the UK economy at present".