Bank's market arsenal in focus after rate cut

By Christina Fincher - Analysis

LONDON (Reuters) - The Bank of England has acknowledged the credit crisis is worsening but it may need sharper implements than interest rates to head off a severe consumer-led slowdown.

The central bank cut its official lending rate this week for the third time in five months, but banks, fearful they will be left with illiquid assets on their books and cash-flow problems, are not passing the lower rates on.

With banks clinging on to all the ready cash they can, the cost of borrowing for households -- whose reduced spending could spell serious trouble for the economy -- has barely budged, or even risen.

Two of Britain's top lenders, the Nationwide and Alliance & Leicester raised their fixed lending rates for new mortgages on Thursday within hours of the Bank's decision to cut the base rate to 5 percent.

A typical two-year fixed mortgage rate is at its highest since mid-2000 despite official interest rates having fallen to their lowest in more than a year.

"The problem for the Bank of England is whether it is pushing on a string," said Daragh Maher, a strategist at Calyon.

"If the traditional base rate cut is not the remedy to this disruption, then the likelihood is it will have to come up with measures to more directly target the money market."

The problem is that official interest rates are a very blunt tool when commercial banks would rather hoard cash than lend it.