The Bank of England moved yesterday to inject extra funds into London’s short-term money markets, making good on its pledge last week to take new action to reduce financial stresses from the worldwide credit squeeze.

The Bank’s move to supply an extra £4.4 billion in additional capital reserves to UK banks through its weekly money market operations — the maximum it committed itself to in measures it unveiled last Wednesday — appeared to have achieved some success in reining in disruptive increases in money market interest rates caused by banking groups hoarding cash.

In a sign that the Bank’s intervention may be reducing market strains, the overnight commercial lending rate for loans between banks fell back yesterday to 5.87375 per cent. That was still markedly above the ideal level of 5.75 per cent, matching the Bank’s base rate, but far below the 6.2475 per cent peak hit on September 3.

At the same time, the three-month “Libor” interest rate in the interbank lending market also fell back from the recent highs that helped to spark a chorus of City criticism of the Bank’s management of the money markets. Yesterday’s three-month Libor rate was fixed at 6.88 per cent, down from its recent nine-year high of 6.90250 per cent.

The Bank also surprised the City with a more generous than expected relaxation of its rules for the amounts banks must keep on deposit with it to settle their accounts each day. Previously, it allowed commercial lenders to undershoot the required amount by no more than a modest 1 per cent.

Yesterday, however, it said it would widen this margin to 37.5 per cent. The move should have the effect of encouraging banks to be more willing to lend to each other, thus reducing the threat of a seizure in the financial system.

The reductions in short-term overnight and three-month market interest rates were welcomed by the British Bankers’ Association. “We hope this is the first indication that the credit markets are finally beginning to ease,” Angela Knight, its chief executive said.

The Bank’s steps came as the Ernst & Young ITEM Club, the independent forecasting group, joined City analysts in sounding warnings over the potential toll from the credit crunch.

ITEM said that, on a “worst-case scenario”, the knock-on effects on consumer spending, the housing market and the financial sector could wipe up to 1 percentage point off Britain’s annual growth rate next year.

Professor Peter Spencer, ITEM’s chief economist, said that although the impact may be contained within the financial services sector, there were “worrying signs that it could spill over on to the high street and the housing market”.

A Reuters poll of City economists showed a consensus forecast for the economy to slow sharply next year and grow by just 2.3 per cent, after a 2.9 per cent expansion this year.

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive