Lenders demand rate cut as credit markets deteriorate

Britain's biggest mortgage banks have demanded that the Bank of England cut interest rates as funding pressures on European money markets tightened even further.

The Council of Mortgage Lenders (CML) warned that the frozen market for mortgage-backed securities had left lenders struggling to raise funds. Banks have the option to reduce their lending, but that will cut choice and increase costs for borrowers.

New retail deposit inflows to mortgage lenders were less than 45bn in the last year and this is not enough to support the 90bn net growth in lending the CML predicts for next year, it said.

"With wholesale markets still dysfunctional, funding pressures have started to crystallise for a number of lenders," said the CML in its latest market commentary. "The case for the Bank of England intervening aggressively to bolster liquidity has grown stronger as market conditions have deteriorated in recent weeks."

The Bank has indicated that there will be two quarter-point rate cuts next year but it may need to act earlier, said the CML. The Bank of England's Monetary Policy Committee (MPC) meets on Thursday to set interest rates. Expectations had increased that the MPC would cut rates to stop the financial crisis from spreading into the wider economy. But sterling rose yesterday as traders digested comments from the Bank's Governor, Mervyn King, and bet that the MPC would leave rates on hold to keep inflation in check.

Mortgage lenders have increasingly used the capital markets rather than retail deposits to fund their lending in recent years. But since the credit crunch caused markets to seize up, lenders have been threatened with running out of money.

Fears have surrounded the financial strength of Bradford & Bingley and Alliance & Leicester but on Thursday, both banks reassured investors that they had funding in place until towards the end of next year. But both banks have had to go outside the public markets for funding. B&B has raised money through private placements of debt and selling non-core loans, while A&L secured 4bn of loans from Credit Suisse to help shore up its liquidity.

But the CML said alternative methods of funding were "uncertain". The market for covered bonds, which are ultra-safe mortgage-backed securities, reopened last week after a shutdown but the rates investors demand to buy the bonds have stayed high.

Money markets continued to tighten yesterday as banks charged more to lend to each other to meet funding requirements for their financial year ends. The sterling three-month inter-bank rate continued to climb to its highest rate since 18 September. London inter-bank rates for one-month euro rose to 4.82125 per cent, the highest for more than six years, despite the European Central Bank taking extra steps to calm money markets by doubling the length of its regular lending to banks to cover liquidity requirements over the year-end period.

Standard Chartered economists predicted that between $2trn and $5trn of liquidity could be taken out of the financial system as banks hoard cash to cover hundreds of billions of dollars of potential writedowns related to sub-prime losses. "The global credit crunch is reducing the amount of dollars available throughout the world... The liquidity situation is unlikely to improve in the short term and market volatility is likely to rise."

In the US, Ben Bernanke, the Federal Reserve chairman, said the Fed had to be "exceptionally alert and flexible" as turbulence in markets increased. His comments raised hopes the central bank would cut rates this month.