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* LIBOR scandal raises doubts over BoE insider as governor
* Lawmakers "frustrated" by BoE's failure to spot Libor risk
* Deputy governor Tucker has challenge
By David Milliken and Sven Egenter
LONDON, July 12 (Reuters) - Paul Tucker, the long-time favourite to become the next Bank of England chief, was quick to brand the Libor rate-rigging scandal "a cesspit" earlier this week -- but the twists and turns of the saga have left doubts about whether he will now get the top job.
A gruelling parliamentary inquiry into the scandal gripping the City of London didn't deal a mortal blow to the deputy governor's chances of succeeding Governor Mervyn King. But it has shortened the odds on an outside appointment because the central bank, on top of its main monetary policy mandate, is set to become arguably the world's most powerful regulator.
Until the eve of Monday's hearing, Tucker -- who has spent his career at the Bank of England -- was the front-runner to take over from King next year, but bookmakers then put former top civil servant Gus O'Donnell fractionally ahead.
"It would have been very difficult for (Tucker) to have a triumph (at the hearing) ... and he didn't," said Karel Williams, a professor of accounting and political economy at the University of Manchester.
The scandal concerns Barclays' admission that its traders manipulated the bank's contribution to the London Interbank Offered Rate, or Libor, the rate at which banks lend to each other overnight and which is the benchmark for many interest rates.
The BoE got dragged in when a 2008 memo from Barclays' former chief executive Bob Diamond, who was forced to resign over the scandal, appeared to suggest that Tucker had condoned the rate-rigging.
More than two hours of questioning of Tucker by lawmakers uncovered no evidence that this was the case.
However, the legislators on parliament's influential Treasury Select Committee -- the main external body to which the BoE, UK bank regulators and the finance ministry are accountable -- were unimpressed by Tucker's and the central bank's failure to sense there could be something amiss a year earlier in 2007.
"It doesn't look good, I have to tell you," committee chairman Andrew Tyrie told Tucker during his evidence session.
Tucker's testimony may also not have endeared him to finance minister George Osborne, who starts the hunt for a new governor in earnest in a couple of months' time.
Osborne has had fiery exchanges with opposition finance spokesman Ed Balls about the Labour Party's responsibility for the LIBOR scandal, which took place when it was in power.
Osborne implied in a magazine interview last week that figures close to the then-prime minister, Gordon Brown, might have leant on Tucker to pressure Barclays to improperly lower Libor rates.
But asked on this, Tucker said "absolutely not", prompting calls from legislators for Osborne to retract his claim -- which would be politically highly embarrassing.
Tyrie's concerns reflect a broader worry from his committee that the BoE is too hierarchical and slow-moving to take on the mantle of financial regulation that will be handed to it next year as part of wide-ranging reforms after a financial crisis that cost Britain hundreds of billions of pounds.
"One does rather question -- when Mr Tucker and the Bank were so incurious in the years after 2007 -- whether much good is coming from putting the Bank in charge of so much," he said the University of Manchester's Williams.
Stewart Hosie, a Treasury Committee member, agreed up to a point. "I am very frustrated with the evidence from the central bank and from Barclays. Nobody knew anything about what was going on," he told Reuters.
But he added that this was much a failure of an entire regulatory system as of the BoE alone or Tucker himself.
Mark Garnier, another member of the Treasury committee, said the hearing had not sunk Tucker's chances, but he would need to show that he had learnt from the Libor debacle.
"There is no such thing as a blameless candidate," he said.
Other observers say Tucker's real problem is an increasing push for an outside candidate, possibly O'Donnell, who headed Britain's civil service until last year and closely advised prime ministers Tony Blair, Gordon Brown and David Cameron.
On paper, Tucker is the stronger candidate, with years of experience in monetary policy and financial stability. But as the BoE gets more powers while its record remains under question, there is pressure to consider others.
"There might be an argument that there should be a new broom, which Tucker will find it hard to argue against," said BNP Paribas economist David Tinsley. "There are some obvious advantages to refreshing the institution at the top."
O'Donnell, unlike Tucker, has experience of managing a very large institution, and the BoE will double in size next year when it takes on many of the staff and responsibilities of the Financial Services Authority, which is being broken up.
However, the decision is highly political.
Tucker's next public 'job interview' comes on Tuesday when he appears again before the Treasury committee alongside King and FSA chairman Adair Turner -- also a contender for the governor's job -- to present the BoE financial stability report.
He might want to take heart from the experience one of his predecessors as deputy governor, the late Eddie George.
George was deputy governor during one of the biggest debacle's of British economic policy in the past 30 years -- sterling's forced exit from the EU's exchange rate mechanism in 1992. Less than a year later, George became the BoE's governor.