The British people's median forecast of benchmark UK inflation in the coming year remained uncomfortably high at 2.7% in August - way above the Bank of England's 2% target and joint-highest since views were first canvassed in 1999.

Sterling fell to a 14-month low against the euro yesterday on growing hopes of a cut in UK base rates from 5.75%, in contrast to the further rise expected before credit and equity market turmoil began in earnest in August, with the single currency rising to 68.74p.

However, the Bank's inflation expectations survey yesterday signalled it was likely to be extremely wary of cutting interest rates soon, in spite of sky-high expectations that the US Federal Reserve will cut benchmark borrowing costs in the world's largest economy from 5.25% next Tuesday.

Members of the Bank of England's Monetary Policy Committee have expressed concern about higher inflation expectations.

Howard Archer, chief UK economist at consultancy Global Insight, said: "The Bank will be disappointed to see that inflation expectations have not retreated at all over the past quarter, despite (annual) consumer price inflation falling back from 3.1% in March to 1.9% in June."

Archer added: "Given the ongoing credit crunch and the likelihood that UK growth will slow over the coming months, we expect the eventual next move in interest rates to be down. Nevertheless, ongoing elevated inflation expectations highlight the fact that there are still significant medium-term inflation risks, and reinforce our belief that the Bank will be wary about any early trimming of interest rates."

Ernst & Young's ITEM Club claimed yesterday that "a worst-case scenario of a full-blown credit crunch" could cut UK gross domestic product growth by one percentage point in 2008 and 2009. The impact would be lighter in the eurozone but the hit in the US could be 1.5 percentage points.

Equity markets were in fine fettle yesterday.

The FTSE-100 index of leading shares finished 57.7 points higher at 6363.9, helped by more reassuring US weekly employment data in the wake of last Friday's shock news that American non-farm payrolls had fallen for the first time in four years in August. Oil companies' shares benefited as US light crude hit a fresh nominal record of $80.20 a barrel.

In New York, the Dow Jones Industrial Average last night finished133.23 points higher at 13,424.88.

The UK stock market could be spooked today by reports last night that the Bank of England had granted Northern Rock emergency funding at a penalty rate in its role as lender of last resort.

The Bank had earlier yesterday taken less dramatic but nevertheless highly-significant action to boost short-term liquidity and bring down the overnight interest rates at which commercial banks can borrow from each other. It made an additional £4.4bn of reserves available in open-market operations - the maximum extra amount it had indicated would be available last week.

It also eased the pressure by widening the range within which banks' specified reserve targets would be remunerated at base rate to plus or minus 37.5%, a greater band than the normal 1% either way, recognising the difficulty some institutions have in anticipating short-term funding needs.

However, Bank governor Mervyn King emphasised on Wednesday there would be a "moral hazard" in any move to bail out financial institutions which have engaged in "risky or reckless lending" - warning this could "sow the seeds of a future financial crisis". He is sticking with his view that it is not the central bank's job to tackle high three-month interbank rates.

These have arisen because of greater demand for liquid assets in the current situation. Institutions are more fearful of lending to each other on a three-month timescale partly because of worries over who has what exposure to the massive default in the US sub-prime mortgage market.

King has made plain his view on the need to avoid bailing out banks without charging a penalty rate of interest, unless there is the danger that the economic cost of not acting will outweigh the "moral hazard" or measures are needed for financial system stability. The European Central Bank has lowered three-month interbank rates by pumping in liquidity on this timescale.

The British Bankers' Association London Interbank Offered Rate (Libor) for three-month euro lending eased slightly to 4.73188% yesterday from 4.74375% on Wednesday. It is closer to the 4% benchmark for the 13-nation eurozone than BBA Libor for three-month sterling is to the UK base rate of 5.75%. Three-month sterling Libor dipped from 6.9025% on Wednesday to 6.88% yesterday. It hit 6.90375% on Tuesday.

Overnight BBA Libor for sterling has dropped from 6.2475% early last week before the Bank of England announced measures to make additional reserves available, to 5.87375%.

In spite of credit market turmoil, the Swiss National Bank yesterday raised its benchmark interest rate by a quarter-point. This move wrongfooted economists, most of whom expected it to follow the ECB's example last week and pause monetary tightening.

The euro, launched in 1999, hit a high of $1.3927 yesterday.