UPDATE 3-Radical steps eyed as UK rates match historic low

* Brown raises pressure on banks to pass on rate cut

* Paper says BoE may use radical cash-injection measures

* Darling says rate cuts alone not enough to boost demand

By Christina Fincher and Peter Griffiths

LONDON, Dec 5 (Reuters) - British Prime Minister Gordon Brown urged banks to pass on in full the Bank of England's latest rate cut as speculation mounted about what steps the Bank could take once its conventional ammunition was exhausted.

Britain's central bank slashed interest rates to 2 percent on Thursday, their lowest level since 1951, and hinted more needed to be done to prevent a credit squeeze tipping the economy into a prolonged recession. [ID:nL4384604]

Brown said on Friday he would talk to Britain's banks, some of which are being bailed out with billions of pounds of public money, to try to persuade them to cut the cost of borrowing.

He also pledged to take unspecified steps to try to reduce the London Interbank Offered Rate (Libor) -- the level at which banks lend to each other and whose recent historically high levels have constrained their ability to cut the rates they charge consumers.

"We are taking action to try and get that (Libor) down," he told a UK breakfast television show. "Banks should really pass on the interest rate cuts." The Daily Telegraph, in an unsourced report on Friday, said the Bank of England was working on radical plans to inject cash directly into the economy.

It said such a move was a "nuclear option" to be used only when interest rates approached zero."

"Measures under consideration include direct purchases of assets, such as government debt or commercial investments, by the Bank or the Treasury, as well as expanding the Bank's balance sheet, a means of pumping extra cash into the banking sector," the newspaper said.

The Bank of England declined to comment on the report but the bank's governor, Mervyn King, has repeatedly stressed that no option has been ruled out.

Giving evidence to a parliamentary committee last week, King openly discussed the mechanics of monetary policy once rates had hit zero, saying there needed to be "close coordination" between the government and the central bank.

WHAT NEXT?

Finance minister Alistair Darling welcomed the BoE's interest rate cut, in a speech in Edinburgh on Thursday, but said monetary policy alone was not enough to kick-start the economy.

Newspapers played to public anger that many banks had not passed on the full one percentage point rate cut to borrowers.

"2 percent, now pass it on," said the Daily Mirror. "The majority of homeowners will not save a penny on their mortgages," said the Daily Mail.

Other newspapers ran pages of analysis looking at how Japan fared when it adopted a zero interest rate policy following the bursting of its credit bubble in the 1990s.

Quantitative easing -- an attempt to stimulate demand once interest rates have been reduced to zero -- was widely assumed to be the next step. The question was how British authorities would go about it. The United States, which has interest rates of just one percent, is already engaging in a form of quantitative easing by buying mortgage-backed securities issued by Fannie Mae and Freddie Mac.

Brian Hilliard, chief UK economist at Societe Generale, said Britain could follow the United States' lead by buying bonds or commercial paper to boost the money supply.

"It's a brave new world and nothing has been ruled out, not even full-scale nationalisation of the banking system," he said.

Britain's financial regulator proposed rules on Thursday that would require banks to buy billions of pounds of government bonds in reserves to make them less vulnerable to market shocks.

The proposals, set out in a consultation paper, assume banks would be required to hold 6 percent to 10 percent of assets in government bonds -- a move that would result in purchases of 87 billion to 353 billion pounds, according to the Financial Times.

Analysts said such bond purchases could help keep longer-dated market interest rates subdued but would come at a price to banks who would be forced to lock in yields at record lows.

For a scenarios box on further measures Britain could take, double-click on [ID:nL4606999] (Editing by Simon Jessop)