Page last updated at 18:54 GMT, Tuesday, 25 November 2008

Governor warns banks on lending

Mervyn King
The Bank of England faces a tough challenge

Mervyn King has warned that the UK economy will go into "a steep recession" if the commercial banks don't resume normal lending levels.

Speaking to the Treasury Select Committee, the governor of the Bank of England said "this was more important than anything else at present".

He said the government "may have to intervene directly" to ensure the banks start to increase their lending.

Mr King added that nationalising banks could not be ruled out.

We will take whatever action is necessary to ensure that inflation is close to target in the medium term
Mervyn King

"I think given what we have seen it would be an extremely brave person that would rule anything out," he said when asked whether nationalising banks was a possibility.

"It's very unlikely to be the first option. Remember that the government now owns the majority holding in shares in more than one bank."

Meanwhile, Chancellor Alistair Darling told the BBC that the situation was "urgent", saying more banks needed to "step up to the mark" and increase lending to small firms.

"If they do not do it we will have to consider what further action is appropriate," he said.

'Extraordinary circumstances'

In the more immediate term, Mr King said UK banks may require additional government funds than they have already received.

Bank boss explains economic outlook

However, he added that he hoped the current rescue package would start to work.

So far the government has pledged to spend up to £37bn to buy stakes in three banks - Royal Bank of Scotland, Lloyds TSB and HBOS.

The Bank of England has lent further billions of pounds to the wider banking sector.

Mr King's testimony came a day after Chancellor Alistair Darling presented his pre-Budget report.

The governor said he welcomed the chancellor's £20bn stimulus package, which includes a cut in Value Added Tax (VAT) to 15% from next Monday.

Mr King said the move was "perfectly reasonable and appropriate" given the "extraordinary circumstances".

Lower inflation

Turning his attention to inflation, Mr King warned that the risk it could fall below 2% in the medium term has "increased significantly" in recent weeks.

Alistair Darling
Mr King said he welcomed Alistair Darling's pre-Budget report

He said this was due to the sharp fall in global oil and commodity prices, and declining consumer demand.

UK inflation fell to 4.5% from 5.2% in October. The government wants inflation to be as close as possible to 2%.

This Bank of England targets the Consumer Price Index, which excludes the effects of mortgage interest payments.

"We will take whatever action is necessary to ensure that inflation is close to target in the medium term," Mr King said.

UK interest rates are currently at 3% following a 1.5 percentage point cut at the start of this month, and many economists are forecasting a further cut in interest rates in December.

While Mr King would not directly comment on future rate movements, analysts said he did little to cool expectations of a further reduction next month.

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