Credit crunch makes rate cut more likely-BoE's King

By Sumeet Desai and Matt Falloon

LONDON (Reuters) - Tighter lending conditions have made the Bank of England more inclined to cut interest rates as the credit crunch enters a new and difficult phase, BoE Governor Mervyn King said on Wednesday.

Sterling weakened after BoE Monetary Policy Committee members also highlighted downside risks to the pound, which has fallen about 10 percent on the year on a trade-weighted basis.

"The financial crisis has moved into a new and difficult phase. Across the world, confidence in financial markets is fragile," King said.

Fears have grown in recent weeks that the credit crisis is getting worse and could trigger a sharp downturn in economic growth across the globe.

Asked by parliament's Treasury Select Committee if tightening lending conditions on financial markets had made British policymakers more predisposed to lowering borrowing costs, King said, "Yes."

But he said he expected UK inflation, already running above the central bank's 2 percent target, to rise even further and hit around 3 percent because of soaring utility bills.

Policymakers have been keen to stress this year that higher inflation must not get entrenched in the public mindset and interest rate policy will have to reflect that risk as well as manage the slowing in the global economy.

"The MPC can have little effect on the short-term path of inflation," he said. "What is crucial is that the pick-up proves to be temporary, just as the rise in inflation last year was."

A snap Reuters poll conducted last week found a growing number of economists expect the BoE to cut rates by a quarter point to 5 percent in April, but a majority still think it will wait until May.

READY TO ACT

King, who met top commercial bankers last week, said the BoE stood ready to provide liquidity to financial markets as needed and was working with the banks to seek a resolution to the crisis.

Such a solution, he said, should be paid for by shareholders in the banks which took risks, rather than British taxpayers.

King said on Wednesday the BoE should not follow the example of the U.S. Federal Reserve with big interest rate cuts and said central banks were taking similar action to ease lending conditions by providing additional funds as required.

"I don't think there is any significant difference between the approaches of the different central banks," he said.

He added that while December's co-ordinated action by central banks to calm jittery markets had helped to boost confidence, he was concerned that last month's joint efforts had not had as much impact.

"I want to assure you that the Bank will provide the liquidity assistance that the system needs in order to restore confidence," King said.

"Such lending can be only a temporary measure, but it can be a useful bridge to a longer-term solution."

(Additional reporting by Christina Fincher and Luke Baker; editing by Stephen Nisbet)