The economic forecasting group Item Club has warned that the failure of the inter-bank borrowing rate to respond to the cut in interest rates could lead to insolvencies of large UK companies.

Peter Spencer, chief economic adviser to the Ernst & Young sponsored Item Club said: 'The market rather than the bank is now dictating monetary policy… If this problem is not sorted out in the next two to three months we're looking at major insolvencies in UK plc.'

The warning comes as economists and bankers' expectations that the London inter-bank offered rate (Libor) would mirror the change in base rates, which were cut by a quarter point last Thursday.

But three-month Libor dropped only 3 basis points yesterday, following the .25 cut in base rates to 5.5%, The Daily Telegraph reported, as banks want to report strong year-ends.

Banks fear that lending to other banks, in the event of credit market problems, could lead to delayed repayment or a movement of off-balance sheet funds onto its books.

Further reading:

Firms expect 10% jump in insolvencies

FDs prepare for the crunch