LONDON (Reuters) - Lending to British businesses and consumers weakened further last month after the biggest fall in credit card borrowing in almost six years, highlighting the challenge faced by the Bank of England as it readies a new scheme to boost credit.
Despite more than 325 billion pounds of government bond purchases over the past three years, lending conditions remain tight for households and smaller firms with the economy back in recession since late last year, prompting BoE Governor Mervyn King to announce a new scheme in June to aid these sectors.
Some economists expect this Funding for Lending Scheme, which opened for business on August 1, to reduce the need for the BoE to buy gilts to stimulate the economy. But BoE official Paul Fisher warned on Wednesday that it would take more than a few months before the FLS takes full effect.
The most striking number from the BoE's July lending data was a 147 million pound net repayment of credit card bills -- the biggest fall in this type of lending since August 2006, when the 150 million pound decline was the biggest on record.
This drove a 220 million pound drop in overall unsecured consumer lending, the biggest since February, but arguably just as important are figures showing that lending to non-financial companies is 3.4 percent lower than a year ago.
"Overall there is little in these data to suggest a break from recent trends. Business lending continues to contract, while household sector lending is rising at a very modest rate," said BNP Paribas economist David Tinsley.
A bigger-than-expected 1.1 billion pound rise in mortgage lending to households helped counteract the fall in unsecured lending, and the pace of contraction in corporate lending seemed to be slowing.
But overall the figures dampen hopes of a strong rebound in economic activity in July after nine months of recession, and back economists' forecasts for British house prices to stay flat or fall slightly over the coming year.
The Confederation of British Industry slashed its economic forecasts for 2012 and 2013 on Thursday, predicting a 0.3 percent fall in output this year and a meagre 1.2 percent rise for next year, in line with the consensus on a Reuters poll of economists published on August 16.
A separate Reuters poll on Thursday showed that most economists expect the BoE to expand its quantitative easing programme of asset purchases once more in November, raising the target to 425 billion pounds from the current 375 billion.
BNP Paribas's Tinsley said the FLS - which offers cheap funding to banks and building societies if they increase lending to businesses and households - may ultimately contribute to a future BoE decision to halt gilt purchases.
"A few people have said the Bank won't do any more conventional QE and focus on the FLS. I think that is right, but I think it is too early for them (in November). That's a plausible thing for February," he said.
However, other economists doubts the FLS will work well, arguing that a lack of capital and a lack of confidence, not the cost of funds, are the main barriers to bank lending.
The European Commission's monthly economic sentiment index for Britain, which combines activity readings for manufacturing, services, construction, retail and consumer surveys, fell back to 91.5 in August from 94.6 in July.
"The current level suggests the economy is roughly stagnant," said Citi economist Michael Saunders. "There probably will be a technical rebound in activity in the third quarter, but this survey suggests that the UK has not experienced an 'Olympics bounce' in activity," he added.
Editing by Hugh Lawson