Credit losses may be half of estimates

The scale of losses and the economic fallout from the credit crunch may not be as bad as feared and sub-prime write-offs could end up costing less than half market forecasts, the Bank of England said yesterday.

The credit crunch has frozen money markets and rattled consumers around the world, pushing the global economy to the edge of a sharp slowdown after banks lost confidence in each other due to defaults on low-end mortgages in the US.

If the fallout from the crisis turns out to be not as drastic as many fear, the implications for global interest rate - and fiscal - policy will be significant.

Current market estimates of sub-prime mortgages amount to nearly $400 billion (£200 billion) and the IMF has said the wider cost to the financial sector could rise to $1 trillion.

"All of them are potentially significant overestimates of the losses within the wider economy associated with the financial market crisis," the Bank of England said in its twice-yearly Financial Stability Report, estimating actual losses could be closer to $170 billion.

"Using a mark-to-market approach to value illiquid securities could significantly exaggerate the scale of losses that financial institutions might ultimately occur. It will exaggerate to an even greater extent the potential damage to the real economy."

The BoE has been criticised for taking an unsympathetic line on the lending squeeze.

The US Federal Reserve has drastically cut interest rates and, along with the European Central Bank, made cash much easier for banks to get hold of.

However, the Bank of England responded to pressure to ease the squeeze last week, announcing an unprecedented £50 billion swap scheme under which banks can trade in their hard to shift assets for risk-free government debt, which is now going to plan.