Mervyn King, the Governor of the Bank of England, has ruled out following the US Federal Reserve in making "aggressive" cuts to interest rates to stabilise the fragile economy.

Speaking today before the cross-party Treasury Select Committee with other members of the Monetary Policy Committee (MPC), which is responsible for setting the UK interest rate, Mr King said that the bank would not follow the Fed by implementing a number of sharp reductions that have taken the key US borrowing cost to 2.25 per cent.

In contrast, the Bank of England has cut the UK interest rate only twice, to 5.25 per cent, since December.

While Mr King conceded the Bank was more predisposed to lowering borrowing costs as lending in the financial markets continued to tighten, he said that inflation is expected to rise to 3 per cent before falling back to its 2 per cent target later on in the year, reducing the likelihood of steep interest rate cuts in the near term.

Mr King said that the Bank of England was still in talks with British banks about the best course of action to take in addressing liquidity problems in the financial sector.

He said: "We are discussing with the banks how a longer-term resolution of the problem might be reached. It is too soon to say where those discussions will lead, but two principles would underlie any central bank role.

"First, the risk of losses on their lending should remain with banks’ shareholders. The banks neither need nor want the taxpayer to insure them against these losses.

"Second, a longer-term solution must focus on the overhang of assets and not subsidise issues of new assets.

"One of the lessons of this financial crisis is that providers of mortgage finance had underestimated the risks, and hence the true cost, of the securitisation process."

Last week, the Bank announced a series of £5 billion cash injection to boost liquidity in the British banking system, co-inciding with the European Central Bank's €15 billion offer while the US Fed made $25 billion available.

The Bank of England will keep injecting £5 billion until April 9 when the MPC next meets to decide on whether to hold or cut interest rates.

Speaking on the day that the Financial Services Authority published a damning report into the handling of Northern Rock's collapse, Mr King said that banks must hold more capital on their balance sheets.

His comments echoed his European counterpart, Jean-Claude Trichet, President of the ECB, who said today: "Supervisors should ensure that banks retain adequate capital and liquidity buffers."

Mr King attempted to calm jitters today by stating that the economy was not in as bad a state as some feared.

He said: "The heart of the problem is not the real economy; it is in the financial sector itself."

At the same time, Mr Trichet said at before the European Parliament: "With the global system undergoing a process of deleveraging, the euro area financial stability outlook continues to be clouded by considerable uncertainty."

Mr King was appearing before the Treasury Select Committee with the Bank's Deputy Governor, Rachel Lomax, and other MPC members Charles Bean, the Bank's chief economist, Andrew Sentance and David Blanchflower, an arch dove.

The pound fell 0.1 per cent to $2.0036 this morning as Mr Bean said that because of the size of the UK current account deficit, "sterling is likely to move to the downside".

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