Hopes of a cut in interest rates before Christmas were boosted yesterday as a key member of the Bank of England's Monetary Policy Committee said that the toll from recent financial turmoil had intensified the dangers facing the economy.

Kate Barker told business leaders in the North West that the credit crunch is proving more serious than initially expected and the escalating financial upheavals of recent days has worsened the economic outlook.

“The latest developments in financial markets have now increased the downside risks,” she said. “There are real dangers that the impact of these would be a downturn in the economy which is unnecessarily large and would therefore result in a large undershoot of the inflation target.”

With Ms Barker also acknowledging the continuing blight of high and rising inflation, and noting that this is being fuelled by sharp falls in the value of the pound, her remarks did little to alter the City's belief that the Bank will keep interest rates on hold next month despite market upheavals.

Yet her recognition of the heightened threat to prospects combined with further doveish comments made recently by other MPC members fuel optimism that rates will be cut before the end of the year.

David Blanchflower, another external MPC member and the committee's arch-dove, this week stepped up his demands for swift action by the Bank to stave off a severe downturn, renewing his plea for steep rate cuts.

Sir John Gieve, the Bank's Deputy Governor, also suggested that he too is becoming increasingly anxious of the deteriorating growth outlook and indicated that he foresees a sharp retreat by inflation into next year.

As Ms Barker also lined up in an emerging, more doveish camp among the MPC, economists said that the chances of a rate cut in November or December, if not next month, were increasing. “The Monetary Policy Committee will clearly be looking hard at the impact of recent events in our October meeting and as we update our forecasts in November,” she said.

However, she tempered that, adding that it was “ too soon to be clear about the full consequences” of the financial turbulence for the economy.

However, the harder-line members of the rate-setting committee have yet to be convinced of the case for early action, with inflation expected to climb still higher before reaching a forecast peak of about 5 per cent during the autumn.

This week, Andrew Sentance, who along with Tim Besley is the most hawkish MPC member, suggested that he remains in little hurry to back a cut in rates.

Dr Sentance argued that it was important that the Bank did not overreact to volatile markets. He added that, while a recession was now a “real risk” in Britain, if one did emerge it was likely to be much more mild than the severe slumps endured in the early Eighties and early Nineties.

While Professor Besley has now abandoned his long-standing demands for an immediate rates increase, voting for no change at the MPC's meeting earlier this month, he too is seen as being unlikely to swing behind a move to cut rates soon.

Many City economists believe that a cut in base rates is now most likely to emerge in November, unless the financial convulsions grow still worse in the next few weeks.

Howard Archer, of Global Insight, said: “We are becoming more confident that the Bank will cut rates to 4.75 per cent in November. We would not rule out a move as soon as October if the current turmoil persists and appears to be significantly hitting the economy. However, we suspect the majority of MPC members will be reluctant to cut as soon as October.”

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