Bank of England
governor (BoE) Mervyn King has assured market the Bank will
continue to pump liquidity into markets in a bid to restore
confidence to dwindling sentiment.
Speaking before the
Treasury Select Committee (TSC) King said the financial crisis had
moved into a new phase.
He said: 'Across the
world, confidence in financial markets is fragile. It is not that
banks, at least in the United Kingdom, have made loans which are
likely to result in unsustainable losses.'
'The heart of the
problem is not in the real economy, it is in the financial sector
itself. It stems from an 'overhang' on bank's balance sheets of
assets in which markets have closed.'
King pointed out
that these assets cannot be sold or used to secure funding in the
market as they are difficult to finance, which as a result has
created uncertainty in the strength of bank's financial
King said action
from the BoE was necessary to prevent a major shock to the system.
'I want to assure you that the Bank will provide the liquidity
assistance that the system needs in order to restore confidence,'
'Such lending can
only be a temporary measure but it can be a useful bridge to a
He added: 'It is
unrealistic to assume that markets for many asset-back securities
are likely to re-open speedily or, when they do, to their previous
levels of activity. So we are discussing with the banks how a
longer term resolution to the problem might be reached.'
King said it is
difficult to assess where the discussions may lead, but highlight
two principle roles which would underline the BoE stance. Firstly
the risk of losses on lending should remain with banks and secondly
a longer-term solution of focusing on the overhang of assets and
not subsidise issues of new assets.
'One of the lessons
of this financial crisis is that providers of mortgage finance had
underestimated the risks, and hence the true cost, of the
Meanwhile King also
reiterated the Bank had no intention of following the Federal
Reserve's stance on interest rates.
The Fed has embarked
on a series of dramatic rate cuts in the US in the last few weeks a
bid to stave off the growing threat of a recession in the world's
biggest economy. The UK has only made two cuts in this period and
last month opted to keep rates on hold at 5.25% at this month's
King told the TSC
the UK is better placed to withstand the problems in markets, hence
the difference between the BoE rate policy and that of the
'The world economy,
particularly the United States, has weakened, but the recent fall
in sterling should help to cushion the impact of exports.
'And the official
data on retail sales show that spending has this year been
But short term
inflation remains a concern. King told the TSC that the BoE expects
high commodity prices across the world to result in a spike in
inflation to around 3% in the short term.
But he believes
sharp cuts in interest rates will have little impact on short-term
inflation trends. 'What is crucial is that the pickup proves to be
temporary, just as the rise in inflation was last year was.
'Even if commodity
prices remain at their present high levels in the face of a slowing
world economy, our central projection is for inflation to fall back
towards the 2% target, starting later this year.'