BoE eases loan restrictions, but ITEM warns of GDP effect

BRITISH banks have snapped up another £4.4 billion in emergency funding offered by the Bank of England yesterday to replenish liquidity and give them more leeway to borrow without penalty to manage daily cashflow.

The Bank, which has so far taken a largely hands-off stance on the crisis engulfing world credit markets, allowed banks to top up the reserves they hold in central bank coffers by 4.4bn, the maximum limit flagged last week.

More significantly, banks from now on can let their reserves at the Bank fluctuate by 37.5 per cent either side of the target instead of the normal 1 per cent band. Overnight interbank lending rates fell after the news to 5.87 per cent from 5.90 per cent on Wednesday. Three-month rates also eased to 6.88 per cent from nine-year highs above 6.90 per cent hit earlier this week.

"We hope this is the first indication that the credit markets are finally beginning to ease," said Angela Knight, chief executive at the British Bankers' Association.

In just over an hour, the entire extra funding had been taken up.

The Bank offered the additional cash at a borrowing rate of 5.75 per cent - the same as the interest rate but below the London interbank offered rate (LIBOR), which is the level at which financial institutions lend to one another.

The extra cash came into the system a day after Mervyn King, the Bank bovernor, below, said in a submission to the Treasury select committee that, despite his tough stance against taking action to bail out banks - such as that of the European Central Bank, which injected a further 75bn (51bn) into the European banking system this week - he would take steps, such as cutting the interest rate, to avoid severe economic damage.

The Bank offering came as the respected Ernst & Young ITEM Club said in a special report on the credit crunch that a worst-case scenario of a full-blown credit crunch scenario would reduce UK GDP growth by around 1 per cent in 2008 and 2009. For the eurozone, the impact would be lighter while for the US it could be as high as a 1.5 per cent reduction.

Peter Spencer, its chief economic adviser, insisted the latest real economy data remains "reasonably robust". However he added: "ITEM feels there are some worrying signs that this could spill over on to the high street and the housing market."

In terms of the losses, ITEM reckons that, given the US subprime mortgage market is $1.5 trillion in size, a reasonable estimate of losses could be $100-150bn. Spencer added that it "is possible" that the US slowdown will prove contagious to the UK housing market.

Asked if the UK should be able to manage its way out of the crisis, he added: "We believe a full-blown credit crunch is still some way off but that more 'nursemaiding' by central banks along the lines of the 1998-9 crisis may be necessary to ward off the threat from the current financial market volatility.

"There may also be a need on the part of the authorities in the major economies to consider a temporary relaxation in regulatory capital requirements to ease the impact of the balance sheet adjustments now facing banks."