Britain threw its troubled banks their second multi-billion pound lifeline in three months today and laid the foundations for the Bank of England to increase money supply as it seeks new ways to boost the economy.
Despite assurances any impact on the public finances would be temporary, gilt futures and sterling fell on the news but bank shares were mixed, with Barclays rebounding after sharp falls late Friday.
Sterling reversed early gains, falling more than 0.3 per cent against the dollar to a session low of $1.4682 and the euro gained to 90.5 pence, the high of the day so far.
The latest plan will see the government increase its stake in Royal Bank of Scotland (RBS) to 70 per cent after the bank announced on Monday the biggest loss in British corporate history.
Banks will be able to insure themselves against losses on their riskiest assets. The government will offer guarantees on their debt and set up a £50-billion fund to buy up high-quality securities to get cash flowing freely again.
With figures this week expected to confirm the economy is now in recession for the first time since 1992, finance minister Alistair Darling said the multi-pronged plan was designed to kickstart lending to credit-starved consumers and companies.
"If we don't get lending going, the recession would be longer and deeper and more painful than would otherwise be the case," Mr Darling said.
The government is playing for high stakes. Prime Minister Gordon Brown won high praise for the country's first bank bailout last October which was emulated around the world but a poll on Sunday showed his popularity waning again with an election due in less than 18 months.
The problems are being felt right across the world with hundred of thousands of jobs disappearing on both sides of the Atlantic as companies unable to raise funding go to the wall, with even some of the biggest banks collapsing.
In the United States, one of President-elect Barack Obama's first tasks will be to figure out how the second half of a $700 billion bailout package can be administered so credit can flow again after a crunch that started in August 2007.
As part of the latest UK package, lenders would have to identify their riskiest assets which they could then insure with the government for a fee. They would still be liable for initial losses but could at least put in a ceiling, boosting confidence.
The Treasury said it would also extend the window for its Credit Guarantee Scheme which underwrites debt for banks that were recapitalised by the government - to the end of this year.
It will also create a guarantee scheme for asset-backed securities starting in April that will build on the recommendations of a government-sponsored report late last year.
The Bank of England, meanwhile, will offer cash at its discount window for a year as well as just 30 days.
It will also get a new £50 billion facility to buy high -quality assets and most strikingly will be able to use this framework to boost the money supply, so called quantitative easing, in order to boost the economy as it runs out of room on interest rates.
The central bank cut interest rates to a record low of 1.5 per cent this month and, like central banks around the world, has been looking at how it can ease monetary conditions once rates cannot fall any further.
"The Asset Purchase Facility will provide an important additional tool to improve financing conditions in the economy," said BoE Governor Mervyn King.
The Treasury said it would also no longer run down the loan book of Northern Rock, the bank it nationalised last year.
The government said the package would have only a temporary effect on the public finances but gilt futures fell sharply at the open. Most banking shares, however, rose after the sharp falls at the end of the week.
Reuters