On Wednesday morning, at the gleaming headquarters of the Financial Services Authority in London’s Canary Wharf, the men who will determine whether Britain’s economy can emerge unscathed from the crisis in financial markets met to review the situation.

Paul Tucker, the Bank of England’s executive director responsible for markets, led a team of Bank officials. Sir Cal-lum McCarthy, chairman of the FSA, and Hector Sants, its recently-appointed chief executive, led for the hosts.

Facing them were senior figures from the top banks, including Stephen Green, HSBC’s executive chairman, Johnny Cameron, chief executive for corporate markets at Royal Bank of Scotland, Bob Diamond, chief executive of Bar-clays Capital, Eric Daniels, chief executive at Lloyds TSB, and Lindsay Mackay, HBOS’s head of treasury.

In the exchanges that followed, the agenda was clear. The Bank and the FSA wanted to know how serious the liquidity squeeze was and what the likely knock-on effects were for the real economy.

“The Bank is watching the situation very closely,” said one senior banker present. “What nobody knows is how this will feed into the real economy. No bank will escape a hit but I doubt that it will be a mega number that will blow a hole in the balance sheet. The real issue is over liquidity and whether some bank will be short and create a run on the institution.”

For the banks, the issue was whether the Bank of England would follow the European Central Bank (ECB) and Federal Reserve and help ease the crisis by pumping in liquidity. Diamond last week contrasted the Bank’s tactics with the “thoughtful moves” by the ECB and Fed.

Later that morning, the Bank announced it would supply up to £4.4 billion of extra liquidity to the markets for the next three weeks, in order to get the overnight rate in the money markets, which had risen sharply, down to something near the 5.75% Bank rate.

But the move, given only a muted welcome, failed to address the banks’ concerns about the three-month interbank rate. The so-called Libor (London interbank offered rate) acts as the base for much of the lending in the economy. It had also risen, to more than a percentage point above Bank rate, touching 6.9%. But the Bank said it could do nothing about this. “These measures are not intended, nor can be expected, to narrow the spreads between anticipated policy rates and the rates at which commercial banks can borrow from one another – for example, the three-month interbank rate,” it said.

Critics say the Bank is inflicting unnecessary pain and damaging London’s reputation. “A lot of people on the trading floors have been saying that it is too little and too late, especially if you compare it to the actions of other central banks in the past month,” said one investment-bank economist.

Another senior strategist agreed. “People do not feel the measures they have taken are going to significantly change the situation,” he said. “The longer the money markets remain stretched the greater the risk it will impact the economy.”

Willem Sels, head of credit strategy at Dresdner Kleinwort, called on the Bank to show a greater sense of urgency. “Mon-ey-market stability needs to return as soon as possible,” he said. “Central banks need to continue to inject liquidity and the Fed will need to cut. The market needs to believe that they will do everything to support the banking sector. This needs to be done quickly. September is a dangerous month.”

Not everyone thinks the complaints are justified. The Bank’s supporters say there is little difference in the gap between three-month money market rates and so-called policy rates (Bank rate and the Fed funds rate) in Britain and America, suggesting the Bank’s tactics of supplying only limited liquidity are not to blame.

“The long-term credibility of the Bank is at stake if they bail out careless lenders and greedy investors,” said Alan Wilde, deputy head of fixed income at Barings Asset Management.

A senior fund manager said: “The Bank has been right to be careful and not make a knee-jerk reaction just because investment banks are squealing about deals that have gone wrong.”

But while the credit crunch persists, the recriminations may have to wait. One legacy of the crisis sparked off by the American sub-prime lending fiasco is that a huge amount of commercial paper – market IOUs – that nobody much wants has to be “rolled over” or refinanced. This week alone, some $113 billion of such paper has to be rolled over. In the short-term, the consequences could be another sharp spike in money-market interest rates.

“Asset-backed commercial paper is rolling off every day and the banks are taking more and more on to their balance sheets, which is using up capital,” said Paul Mortimer-Lee, global head of market economics at BNP Paribas. “It is both a liquidity and a capital crisis.”

ON the sunlit shores of lake Como, some of the world’s movers and shakers have been meeting in recent days at the annual Ambrosetti Forum at Villa d’Este. A kind of late-summer Davos, it usually offers an opportunity for quiet reflection, a world away from the dealers’ screens and the market frenzy.

On this occasion, though, it provided a forum for more sobering thoughts on the outlook. On Friday, American figures showed a drop of 4,000 in nonfarm jobs last month, the first fall for four years, against expectations of a 100,000 rise.

One leading economist said he would be “gobsmacked” if the Fed, under Ben Bernanke, did not cut the Fed funds rate at its next meeting in nine days. Alan Greenspan, Bernanke’s predecessor, warned that there were similarities between the current crisis and the 1987 stock-market crash and 1998 hedge-fund crisis. Many are now looking for a 50 basis-point reduction from the Fed, which would take the rate down from 5.25% to 4.75%.

Rodrigo de Rato, managing director of the IMF, who was at the lake Como meeting, said some slowdown in global economic growth was inevitable.

“We now expect some downward revisions to our growth projections, especially next year,” he said. “The revisions are likely to be largest for the United States, but we may also see some impact in the euro area. This will have implications for monetary policy.”

Jim O’Neill, chief economist at Goldman Sachs, who was also at the meeting, said the prospect was still for a slowing of global growth. “I look at this situation and I say ‘Thank God for China’,” he said. “We shaded down our US forecasts some weeks ago. If there was any evidence that things were starting to go wrong in China, I’d be much more worried.”

The big unknown is the extent to which the credit crisis will affect the real economy. David Kern, economic adviser to the British Chambers of Commerce, warned that the slowdown already in prospect for the British economy was likely to become more severe.

“The increase in interbank rates is in effect a tightening of monetary policy,” he said. “It is likely to increase the cost and reduce the availability of money to businesses. This is quite dangerous.”

There is also a new uncertainty in the housing market. According to an analysis by the Council of Mortgage Lenders, the most seriously affected lenders will be those who fund their mortgages mainly from the wholesale markets and hold them in securitised form.

For mortgage borrowers, recent weeks have brought relief from the fear of further interest-rate rises. But the net effect of the scramble for liquidity is likely to be that the rise in the cost of borrowing already seen in Britain’s own sub-prime sector will spread to ordinary mortgages.

Michael Saunders, chief UK economist at Citigroup, warned of the impact of this on housing. “We expect housing turnover to fall about 20% from recent levels, and house-price inflation to fall to zero, in the year ahead,” he said.

Saunders thinks rate cuts will be on the Bank’s agenda in the next three months if the money-market crisis persists. The game has changed, and nobody yet knows the result.

BANK’S STEADYING HAND

UNTIL the present crisis blew up, Paul Tucker had two main worries. One was whether he could rid himself of his reputation as the “uber-hawk” on the Bank of England’s monetary policy committee. The other was living with the label “future Bank governor”.

Tucker, 49, joined the Bank 27 years ago, fresh from Trinity College, Cambridge. Keen to give a rising star broader experience, the Bank lent him to a merchant bank’s corporate finance department, and then to the Hong Kong monetary authorities to help sort out the mess after the 1987 stock-market crash. On his return, he worked as private secretary to Robin Leigh-Pemberton, Eddie George’s predecessor as governor, during the period of Britain’s ill-fated membership of the European exchange rate mechanism (ERM).

In recent months he has no longer been the most hawkish member of the MPC, ceding that role to Tim Besley and Andrew Sentance. But, as the Bank’s executive director for markets, he has found himself at the eye of the credit storm. Tucker is the Bank’s point man in the markets, responsible for its operations in the money markets and the currency markets. The crisis comes only months after he reformed the framework for the Bank’s operations in the money markets.

Tucker is a City man and recent criticism of the Bank from within the Square Mile will have hurt. Those who know him say he has dealt with these criticisms robustly, seeing many of them as misplaced, and has been keen that the Bank’s actions are seen as measured, and not giving the impression of panic.

He also believes it is not the Bank’s job to protect “unwise lenders from the consequences of their past decisions”.

The next few weeks will determine whether he has got it right.

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