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Mervyn King, the governor of the Bank of England, has admitted that a further cut in interest rates is likely when the monetary policy committee (MPC) meets next month.

Facing the Treasury select committee today to discuss the Bank's February inflation report Mr King referred to the fragility of the financial markets but was at pains to make the distinction between those markets and the real economy despite the credit crisis moving into a "new and difficult phase."

Mr King said: "Across the world, confidence in financial markets is fragile. It is not that banks, at least in the UK, have made loans that are likely to result in unsustainable losses.

"The heart of the problem is not in the real economy. It is in the financial sector itself."

But he also warned the credit crisis was having a greater impact on the UK economy than had previously been anticipated.

Mr King said the bank of England would continue to provide financial assistance to banks in order to prevent "market shock." The promise follows the injection of a further £5 billion into the financial markets from the Bank last week and a meeting between the governor and heads of the major UK banks.

And he said the MPC was willing to cut interest rates to stimulate economic growth but pointed out that it had a "difficult balancing act" to meet its inflation targets.

He totally rejected accusations the Bank had mishandled the current economic situation and that confidence in the economy had been severely damaged saying: "We set interest rates to meet our inflation target and we are on track. There are big risks on either side, if the evidence moves in favour of one set of risks than another then we will respond."

He also added that it was "important for people not to confuse a slowdown in the world economy with words like depression."