Bank steps in to offer £40bn loans

The worsening financial crisis forced the Bank of England into an unprecedented intervention today as it offered at least £40bn to cash-strapped banks.

Lenders are hiking mortgage costs because of a sudden surge in the rate at which banks lend to each other for three months, as those hit by the credit crunch hoard funds.

The Bank usually offers three-month money on a monthly basis, but will hold auctions every week from Monday for the first time while the pressures in wholesale markets remain.

The central bank has not revealed the sums involved in future auctions but they are likely to be of a similar size to Monday's if desperate banks snap up the funds.

The move comes as interbank three-month lending rates soared to 6.28 per cent yesterday - way above the Bank's official 5 per cent base rate.

This spread is now wider than at the time of Northern Rock's emergency bail-out by the Bank of England just over a year ago, when three-month inter-bank rates were 1.15 per cent above base rate.

The three-month rate is a key one for mortgage lending and today HSBC, Barclays' lending arm the Woolwich, and internet and telephone bank first direct all said they were passing on recent increases in the cost of borrowing to customers.

JP Morgan economist Allan Monks said: "There is still a lot of stress in the sterling money market."

Despite the Bank's auction, he said any progress on the $700bn (£381bn) banking bail-out in the US could have a bigger effect in easing money market pressure. "That is the more significant factor," he said.

Central banks including the Bank of England stepped up other efforts to ease the crisis today.

The Bank is lending $30bn (£16.2bn) for a one-week period, with another $10bn (£5.4bn) being made available on an overnight basis.

It said the operations - mirrored by other central banks - were intended to ease funding pressure on banks at the end of the third quarter. Both were slightly oversubscribed by banks.

The injection extends last week's initiative by the US Federal Reserve to use the Bank of England and the European Central Bank, as well as central banks in Switzerland, Japan and Canada, as conduits for dollar funds.

A statement said: "Central banks continue to work together closely and are prepared to take further steps as needed to address the ongoing pressures in funding markets."

The US Federal Reserve has been pumping the money into overnight dollar markets after lending between banks fearful of losses virtually ground to a halt after last week's financial turmoil.

In the wake of the Lehman Brothers bankruptcy and rescue takeover of Merrill Lynch, financial institutions have been gripped with fear.