‘New firepower’ deployed to help UK’s shrinking economy

Bank lending could be increased by as much as £80 billion under a bold new 'funding for lending' scheme unveiled by George Osborne and Mervyn King last night.

The chancellor and Bank of England governor announced details of a new stimulus package designed to encourage a return to growth in the UK economy in their speeches to the annual Mansion House dinner in the City.

Under the measures now being rolled out the Bank is making cheap loans available to banks on the condition that they increase their lending.

This is the first time the Bank has sought to intervene in the 'real economy'. Previous steps like quantitative easing have focused on helping maintain liquidity in commercial banks.

"We are not powerless in the face of the eurozone debt storm," Mr Osborne declared last night.

"Together we can deploy new firepower to defend our economy from the crisis on our doorstep."

Bank of England governor Sir Mervyn said he hoped the scheme could be in place within a few weeks.

It will provide funding for banks over an extended period of several years, lending against a much greater value of collateral in the form of loans to the real economy.

"The world economy is a much less welcoming environment in which to rebalance the UK economy than two years ago," Sir Mervyn told the lord mayor and guests.

"Not only have the euro-area problems escalated to the point where exit for Greece and other periphery countries is the subject of widespread speculation, but signs of a slowing in China, India and other previously buoyant emerging countries, such as Brazil, are appearing daily."

Mr Osborne countered: "The government – with the help of the Bank of England – will not stand on the sidelines and do nothing as the storm gathers.

"We are rolling up our sleeves and doing everything possible to protect British families and firms."

Labour has responded with scepticism to the measures, claiming they will not make a difference. Shadow chancellor Ed Balls said the government's approach was flawed because it did not address the coalition's austerity agenda.

"Monetary policy and liquidity can't solve this problem, because fundamentally this is about confidence… that goes to the deeper problem with the government's economic strategy," Mr Balls told the Today programme.

"The reason it's happened in Britain so much harder than other countries is because the fiscal crunch the chancellor imposed on the economy two years ago has choked off the recovery. The chancellor's diagnosis has never been right."

The Bank of England's move won approval from the Treasury select committee, however. Chair Andrew Tyrie, a Conservative, said the liquidity measures appeared "very encouraging".

"These are exceptional circumstances. They require exceptional measures," he commented.

"It is not just welcome that the Treasury and the Bank of England are working together to secure recovery. It is essential."

Sir Mervyn also gave further details about the 'extended collateral term repo facility', originally announced last December, which will provide more liquidity for banks.