The Deputy Governor of the Bank of England admitted yesterday that the Bank had underestimated the severity of the economic crisis after failing to spot the danger of the consumer borrowing binge and soaring house prices.

Sir John Gieve, deputy governor for financial stability, said that although the Bank had forecast a correction after seeing “some crazy borrowing” and unsustainable rises in some asset prices, such as house prices, it had not foreseen the depth of the downturn.

Average house prices rose 227 per cent between 1995 and the peak of the market in summer last year, figures from Halifax show, while UK consumers have run up debts of £1.4 trillion. “Why didn’t we see that it was so serious? I think that’s because we, perhaps, hadn’t kept pace with the extent of globalisation,” he said.

Speaking to the BBC, Sir John, who is stepping down as Deputy Governor in March, also called for additional tools to help to avoid a similar crisis, calling interest rates “a blunt instrument”. “We need to develop some new instruments, which sit somewhere between interest rates, which affect the whole economy . . . and individual supervision and regulation of individual banks,” he said.

Sir John also said the UK banking system had been on the brink of collapsing before the Government stepped in with a multibillion-pound bailout. “I think we came right to the brink,” he said. “Several of our large banks . . . were in real difficulty.” RBS and HBOS were identified later by the BBC as banks that came close to collapse.

The admission came as the head of the OECD launched a scathing attack on policymakers and central banks, saying that there had been “a truly scandalous failure of regulation” in the crisis. Angel Gurria also said that the global economic downturn could cost 25 million people their jobs.

Sir John’s comments sent the pound tumbling to a record low against a basket of currencies as expectations rose that the Bank will make more aggressive rate cuts in the new year. Tim Besley, another member of the Bank’s rate-setting committee, indicated that more rate cuts are needed to offset the threat of deflation next year. The Bank has forecast that inflation will fall well below its own 2 per cent target next year and fears are growing that it could dip into negative territory.

Economists expect rates to be cut to 1 per cent, falling even lower during the year. Sterling fell to 75.7 on the trade-weighted index, the lowest level since the series began in 1990, and remained near record lows against the euro at €1.05.

Sir John defended the Bank’s failure to curb the consumer credit binge by raising interest rates, saying that such a move could have inhibited growth elsewhere in the economy. “We would have been . . . holding down the level of employment and people would have said this is a wilful reduction in the prosperity of the country,” he said.

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts