LONDON (Reuters) - Banks must resume lending if the UK is to avoid a steep recession, Bank of England Governor Mervyn King warned yesterday, although he said a government fiscal boost should go some way to fending off a slump.

"I am in no doubt that the single most pressing challenge to domestic economic policy is to get the banking system to get lending in any normal sense. That is more important than anything else at present," King said.

However he cautioned against excessive focus on home loans.

The governor told parliament's Treasury Select Committee the BoE might need to cut interest rates more than it would otherwise have done if banks continued not to pass on cuts.

"We will take whatever action we feel is necessary on interest rates to steer the economy back into calmer waters."

King said banks needed to feel confident enough to lend and gave a strong hint bank capital adequacy rules could be relaxed to help ease lending conditions.

Bank lending has effectively dried up as a result of the global financial crisis, and the British government has made reviving lending a key plank of its economic recovery plan.

"These are precisely the times — when you would think it appropriate to reduce the minimum capital requirement at the same time as ensuring banks have enough capital to give them a cushion to absorb future losses," King said.

"I think it is of the utmost importance that tripartite authorities make it crystal clear that regulatory minimum requirements are not being raised, and if anything in these circumstances might be lowered."

King said the economy would go into "steep recession" and banks would end up facing even bigger losses on bad loans if there was no thaw in lending.

However, he said a £20 billion ($30.23 billion) stimulus package announced by the government on Monday should help limit any downturn: "These measures will act to mitigate the slowdown in activity over the next year."

The centre-piece of Monday's package was a 2.5 percent cut in value added tax to 15 percent. The price tag was record borrowing of £118 billion next year, the equivalent of eight percent of national income, and unprecedented gilts issuance.

"A temporary cut in income tax is likely to be saved, a cut in VAT at least gives households an incentive to bring forward some spending," said BoE Deputy Governor Charles Bean.

Bank policymakers gave no hint the package of tax cuts and spending rises would stand in the way of interest rate cuts.

Britain's central bank has cut interest rates by a cumulative two percentage points over the past two months, bringing them to 3 percent, their lowest level since the 1950s.

Investors are betting rates will fall below two percent next year for the first time since records began in 1694.

Despite their comments on lending, BoE policymakers cautioned against excessive intervention in the housing market.

Finance minister Alistair Darling said on Monday the government planned to help revitalise the moribund home lending market by guaranteeing the mortgage-backed securities banks had been using to fund lending until credit markets froze over.

The plan is based on the main recommendation of a government sponsored report into mortgages authored by James Crosby, former head of UK mortgage bank HBOS.

"I'm all in favour of finding ways of encouraging a sustainable rate of mortgage lending but I'm not entirely confident that the best way to do this is to resurrect a form of lending that for rather good reason has fallen out of favour," said King.

His comments came as data showed mortgage approvals more than halved in October.