Warning to banks as King hints at April cut

Governor Mervyn King said the financial crisis has "moved to a new and difficult phase" as the deepening credit crunch increases the risks of a sharp slowdown in the economy.

He said "Yes" when asked by MPs on the Treasury Select Committee if the tighter lending conditions mean interest rate cuts are more likely.

Economists said King's dovish comments suggest he could vote for a rate cut as early as April after resisting such calls this month. The Bank has already reduced rates from 5.75% to 5.25% since December.

Howard Archer, of Global Insight, said: "We now expect the Bank of England to trim interest rates by a further 25 basis points to 5% in April rather than in May as we had previously forecast. Further out, we expect interest rates to fall to 4.5% by the end of the year and to 4% in the first half of 2009."

However, King was adamant that the UK will not follow the same path as the US, where the Federal Reserve has slashed rates from 5.25% to just 2.25% in recent months, including a cut of 75 basis points last week.

King said there were "two quite different policies and two separate sets of circumstances" in Britain and recession-bound America. "This is not an economy that has ground to a halt," he said, adding that conditions in the US are "materially worse" than in the UK.

He added that inflation is still a major concern, having hit 2.5% in February and now heading towards 3% - well above the 2% target.

King said the Bank faced "a difficult balancing act" between rising inflation and slowing economic growth. "We are not going to lose control of inflation in this country," he added.

He also signalled that the era of unfettered liberalism in the banking system is coming to an end, condemning the "hubris" of bankers whose bad decisions had brought crisis to the City.

"There's a lot of hubris around in thinking expansion of financial services was a good in itself," he said. "It's not, it's a means to an end."

King said closer regulation of financial services is inevitable in the wake of the crunch. Financial institutions "will have to hold more capital in the longer run", and have their activities "monitored more carefully" - although he said it was not the time for "knee-jerk reactions".

"I think the pain that will be suffered by the financial institutions this year will keep minds focused on it for a number of years," he said.