The Bank of England warned that defaults on mortgages will increase over the next three months.

The latest Credit Conditions Survey, carried out by the Bank, shows that secured lending to households and small businesses has fallen considerably during the final quarter of 2007.

Most analysts say the worrying trends for the future of UK banking sector will prompt further interest rate cuts by the Bank of England.

The report says that lenders reported a reduction in the amount of secured credit they were willing to make available to households. The most likely reason for this, the Bank claims, is that lenders are reducing their risk appetite and targeting a lower market share. 

The Bank warned that lenders expected a reduced availability of credit over the next three months. Lenders are expecting their default rate to rise in the coming months as many borrowers find their fixed rates expiring. Borrowers who find themselves with higher interest rates may have to default on their mortgage.

Some economists say that a large number of defaults could cause a recession and even a crash in house prices.