Britain's government and the Bank of England will flood its banking system with cash in a coordinated move to get credit flowing through its recession-hit economy, as the euro zone crisis casts a "black cloud" over the world economy.
The country will launch a scheme to provide cheap long-term funding to banks to encourage them to lend to businesses and consumers, and the central bank will activate an emergency liquidity tool, BoE governor Mervyn King said in his annual Mansion House policy speech to London financiers.
The case for pumping more money into the economy via further purchases of government bonds had also increased as the outlook for the economy had worsened, King said, though 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 days before Greek elections that could determine the fate of the euro zone, and as world leaders meet to try to find ways to tackle the currency bloc's crisis and spur the global economy.
British finance minister George Osborne warned of the huge dangers from a collapse of the euro area, again urging euro zone leaders to fix the crisis, but 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."
Britain is still reeling from the 2007-2009 financial crisis that has left many Britons poorer and forced the country to bail-out major 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.
But 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 they gave the BoE leeway to keep monetary policy loose, and said there was still more the central bank could do.
BoE Governor Mervyn King said the central bank will 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 BoE and finance ministry have designed a new scheme, to be launched in a few weeks, that will 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.
It will offer at least 5 billion pounds of loans per month via the operation. 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 after 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.