King reluctant to cut interest rates

Bank of England Governor Mervyn King suggested he's reluctant to cut interest rates to shield lenders from increased credit costs and predicted more "turmoil" in financial markets.

"The current turmoil in financial markets is not over," King said in a speech in Northern Ireland. The benchmark interest rate "will not be set now to insulate the banking system from the re-pricing of risk. But you can be sure that we will do whatever is necessary to keep inflation close to the 2 percent target".

The comments damp speculation that the Bank of England will follow the US Federal Reserve in lowering its main rate to support economic growth. UK inflation won't stay around the central bank's 2 percent target unless the economy slows, King said, repeating a forecast made before the jump in credit costs.

"We will be monitoring closely the impact of tighter credit conditions on demand and output in the coming months," King said. "With investors more wary of risks, banks will find it harder to raise funds. So credit will not be so readily or cheaply available to businesses and households."

The pound was little changed after King's comments, trading at $2.0393 at 6:42 am in London. The UK currency has declined from a 26-year high of $2.0654 reached on July 24, on speculation UK interest rates have reached their peak and the Bank of England will lower borrowing costs early next year.

Northern Rock collapse

King's remarks come after the UK government yesterday extended a guarantee to depositors at Newcastle, England-based Northern Rock Plc. The mortgage provider buckled under the surge in money-market rates last month and was forced to seek an emergency loan from the Bank of England, spurring the first run on a UK bank in more than a century.

King said the panic pointed to the need for a special insolvency law for UK banks to protect depositors, insurance requirements for smaller lenders relying on wholesale funding markets, and more-discreet ways of arranging rescue financing.

He also said the bank has "achieved our primary objective in the money markets" of keeping the rate firms charge each other for overnight loans in line with the benchmark interest rate, currently at 5.75 percent. The rate is the highest among the Group of Seven industrialized nations.

Rates for longer-term borrowing still reflect banks' reluctance to lend to each other after the US subprime mortgage market collapsed.

Interbank rates

The London interbank offered rate for three-month loans was 6.25 percent on Tuesday, according to the British Bankers Association. While that's down from a nine-year high of 6.9 percent on September 11, the rate still hasn't returned to the 6.05 percent level of August 1, before credit markets seized up.

There are some signs that higher corporate borrowing costs and the highest central bank rate in six years are cooling the economy.

Growth in UK service industries weakened to a 13-month low last month, while manufacturing growth slowed more than expected, according to surveys by Chartered Institute of Purchasing and Supply and Royal Bank of Scotland Group Plc.

Bloomberg News

(China Daily 10/11/2007 page16)