LONDON (Reuters) - The government and Bank of England will flood Britain's banking system with more than 100 billion pounds, seeking to pump credit through an economy struggling to escape recession under the "black cloud" of the euro zone crisis.
In his annual Mansion House policy speech to London financiers on Thursday, the Bank's Governor Mervyn King said the country would launch a scheme to provide cheap long-term funding to banks to encourage them to lend to businesses and consumers.
He also said the bank would activate an emergency liquidity tool.
Treasury officials said the government plan could support an estimated 80 billion pounds in new loans, while the central bank's separate scheme will provide monthly 5 billion pound tranches of six-month liquidity to banks.
King said the case for pumping more money into the economy via further purchases of government bonds had increased as the outlook for the economy had worsened, although he again rejected calls for the central bank to buy private assets.
King said the euro zone's woes were leading to a crisis of confidence in Britain which was leading to a self-reinforcing weaker picture of growth.
"The black cloud has dampened animal spirits so that businesses and households are battening down the hatches to prepare for the storms ahead," he said.
Britain's action comes just before cliff-hanger Greek elections this weekend that could determine the fate of the euro zone, as well as a meeting of the leaders of the world's major economies next week to find ways to tackle the currency bloc's crisis and spur the global economy.
Chancellor George Osborne warned of the huge dangers from a collapse of the euro area. He again urged euro zone leaders to fix the crisis and said Britain was taking action to protect its own economy.
"We are not powerless in the face of the euro zone debt storm," Osborne said in his speech at Mansion House. "Together we can deploy new firepower to defend our economy from the crisis on our doorstep."
The country is still reeling from the 2007-2009 financial crisis that has left many Britons poorer and forced the country to bail out big banks with tens of billions of pounds of taxpayers' money.
The government on Thursday announced a sweeping reform of bank regulations aimed at making financial institutions safer, and avoiding a re-run of the crisis which has pushed Britain into recession twice in the last four years.
Britain slid back into recession around the turn of this year, piling pressure on Osborne's embattled Conservative-led coalition government to come up with new ways to boost growth.
The government has pinned its fortunes on a tough austerity plan of tax hikes and spending cuts to erase a budget deficit which still comes in at around 8 percent of GDP.
Osborne defended his debt-cutting measures, arguing that they gave the Bank the leeway to keep monetary policy loose, and said there was still more the central bank could do.
The Bank Governor Mervyn King said the central bank would complement its quantitative easing asset purchase scheme with new steps to encourage bank lending and reduce their funding costs, which have rocketed as a result of the euro zone crisis.
The Bank and Treasury have designed a new scheme, to be launched in a few weeks, that would offer banks loans with a maturity of possibly 3-4 years at below current market rates.
The loans would be made available on condition that banks increase their lending to businesses and households.
In addition, the central bank will activate its Extended Collateral Term Repo facility, created in December, to provide six-month liquidity to banks against a wide range of collateral.
King said now was the right time to activate the scheme, which is aimed at helping banks through phases of exceptional stress.
King hinted that the central bank may also restart its QE programme, which it halted in May having bought 325 billion pounds of British government bonds, and countered accusations that the scheme had lost its effectiveness.
"With signs of a deterioration in the outlook, especially in world markets, the case for a further monetary easing is growing," King said.