(RTTNews) - Bank of England Governor Mervyn King said late Tuesday that the crisis certainly suggested the need for additional policy tools that can moderate the growth of the financial sector and lean against the macroeconomic effects of the credit cycle. The national debt is rising rapidly, not least as the consequence of support to the banking system. "We shall all be paying for the impact of this crisis on the public finances for a generation," King said in a speech in Edinburgh.

In September, the public sector net borrowing surged GBP 6.1 billion from the previous year to GBP 14.8 billion, which was the biggest level for September. At the same time, the public sector net cash requirement rose to GBP 19.4 billion, also the highest for the month of September.

The central bank chief said, "The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history." He said encouraging banks to take risks that result in large dividend and remuneration payouts when things go well and losses for taxpayers when they do not, distorts the allocation of resources and risk management.

King noted that banks and their creditors knew that the government would always stand behind them if things went wrong as they are sufficiently important to the economy. The sheer scale of support to the banking sector is breathtaking, he said.

He assessed that to reduce the probability of failure of these institutions, regulators can impose capital requirements on a wide range of financial institutions related to the risks they are taking. But capital requirements reduce, not eliminate, the need for taxpayers to provide catastrophe insurance. Also, the "riskiness" of a bank's activities and the liquidity of its funding can change suddenly and radically as market expectations shift, King added.

Regarding the asset purchases, King said, "In deciding when and by how much our present programme of asset purchases should be either expanded or reduced, the Monetary Policy Committee will continue to base its decision each month on a judgement of the action required to meet the 2% target for inflation." MPC member Adam Posen favors an extension of the central bank's GBP 175 billion asset purchase scheme.

The National Institute of Economic and Social Research holds the view that the BoE should halt its GBP 175 billion asset purchase programme next month. On Wednesday, the think tank said it sees a recovery in the fourth quarter of 2009 and predicts 1.3% growth next year.

According to King, in the second half of this year, the UK economy will return to positive, if modest, growth." He expects inflation to remain volatile over the coming year.

UK annual inflation had slowed to a five-year low of 1.1% in September and stood below the central bank's 2% target for the fourth straight month.

Inflation is expected to pick up in the months ahead mirroring higher petrol prices, recent weakness in sterling and the reversal of the cut in VAT. To bring spending back on a desirable trajectory is likely to require a pick up in the growth rate of broad money in the economy. That is precisely what asset purchase programme aims to achieve, said King.