Tensions between the Treasury and the Bank of England mounted yesterday as Mervyn King, the Bank’s Governor, abruptly dismissed measures being considered by Alistair Darling to end the mortgage drought.

Mr King signalled his strong opposition to a move being examined by the Chancellor to expand the Bank’s emergency financing programme for lenders, the Special Liquidity Scheme.

The Governor also poured scorn on a second, more controversial measure, whereby the Treasury would temporarily guarantee high-quality mortgage-backed bonds to help struggling lenders to boost the funds available for mortgage lending.

Mr King’s move to dig in his heels against the plans comes after The Times revealed that the drastic steps to revive the near-dormant mortgage market are under active consideration by Mr Darling. The Governor’s opposition threatens to inflame again the Bank’s tense relationship with the Treasury, which saw the institutions at loggerheads during the Northern Rock crisis.

Mr King has always insisted that, contrary to claims by the Chancellor, the Bank’s £50 billion-plus Special Liquidity Scheme, backed by the Treasury and introduced in April, was not designed to breathe life into a mortgage market in which borrowers are struggling to find home loans.

Yesterday, the Governor again spelt out his view that the scheme, under which lenders can swap mortgage-backed securities issued before the end of 2007 for more easily traded Treasury bills, was aimed only at relieving financial stresses on banks and could not be used to boost mortgage lending. He added that the scheme in its present form would close, as planned, in October.

Mr Darling is believed to want to allow banks to swap new issues of mortgage-backed securities through the scheme. However, Mr King argued that such a move offered no solution to securing greater availability of home loans. “Funding is not something a central bank can supply,” the Governor said. “The Bank can swap the stock of assets from illiquid to liquid form. It can’t provide funding to finance investment. That has to come from mobilising savings in the economy. That’s what the financial sector is there to do.”

Mr King dismissed the idea of public backing for new mortgage securities. He said: “It would be a very dangerous move to [have a] situation where the Government saw its major role as guaranteeing lending. Why should the taxpayer take on the risk of borrowing by individual borrowers, some of whom are risky? It’s the lenders who should take the risk . . .

“We don’t guarantee lending to other forms of borrowing. There is no reason why in the long run you need any guarantee of lending to the mortgage market.”

The Governor said the credit crunch afflicting mortgage markets had some way to run as banks faced more losses on past excessive lending. “That, we haven’t seen play out yet, so we have to go through that process,” he said.

Mr King said that markets were now directing more attention to the funding of individual institutions, and the viability of their business plans.

Mr King’s comments came as the Bank boosted hope of cuts in interest rates by the end of the year, or early next year, that could offer some support to the slumping housing market.

City expectations of eventual rate cuts leapt after the Bank forecast that inflation would tumble back below its 2 per cent target over two years, after peaking at 5 per cent in the autumn.

Market bets on a rate cut by December sent sterling to an 11-year low on its trade-weighted index, which ended in London at 90.8. The pound fell below $1.90 against the dollar, closing at $1.8651, its lowest since 2006. It lost 1.5 per cent against a euro, up at 79.71p.