Bank of England Governor quizzed over Northern Rock

Bank of England Governor Mervyn King faces a grilling from MPs today over his handling of the crisis at mortgage lender Northern Rock and the wider turmoil in financial markets.

His cross-examination by the Treasury select committee comes less than a week after the Bank agreed emergency funding for Northern Rock – sparking a run on the UK’s fifth-biggest mortgage lender and jolting confidence in the wider financial system.

Mr King, who has been in the Bank’s hot-seat since 2003, has the “full confidence” of Prime Minister Gordon Brown, Downing Street insisted as the crisis unfolded this week.

But the Government was forced to give cast-iron guarantees over all the deposits of Northern Rock’s savers before the queues of anxious customers subsided.

The Governor is also likely to face questions from politicians over yesterday’s U-turn from the Bank in deciding to pump up to £10 billion into longer-term money markets.

The Bank has moved to prop up overnight markets between banks crippled by fears over exposure to losses on high-risk US mortgages, but had previously refused to intervene in three-month money markets – saying that banks should face the consequences of risky longer-term lending.

But Northern Rock’s woes have been prompted by soaring interest rates in the three-month money markets, where the firm borrows most of its cash for mortgage lending.

The decision by the Bank comes after Mr King said only a week ago that providing short-term liquidity to markets in trouble “encourages excessive risk-taking and sows the seeds of a future financial crisis”.

The Governor will be backed up at today’s hearing by four members of the Monetary Policy Committee (MPC) which meets to set interest rates each month.

Technically, the hearing is on the subject of the Bank’s latest inflation report, published in the first week of August before the shockwaves rippled through global markets.

Royal Bank of Scotland economist Kevin Gaynor said: “Notionally, MPC members are there to discuss the August inflation report. In actuality, the Bank will be under intense scrutiny over the recent shift in its money market policy.”

Mr King has also faced criticism that the Bank acted too slowly to ease the credit crunch after other central banks, including the US Federal Reserve and the European Central Bank, pumped billions into money markets early on in the crisis during August.

But the Bank only acted to ease overnight inter-bank lending two weeks ago and refused to help longer-term money markets before yesterday’s about-turn.

It stressed that the higher rates seen in the longer-term lending markets stemmed from the current difficulty in valuing financial instruments – such as mortgage-backed securities – “rather than a lack of central bank liquidity”.

But yesterday’s announcement, “taken in order to alleviate the strains in longer-maturity money markets”, will allow banks to borrow against a wider range of collateral – including mortgages – for three months.