King warns EU of danger of caution as crisis mounts

Governor calls for global deal on stimulus

An "excessively cautious" response to the economic crisis will lead to the return of "mass unemployment and world recession", the Governor of the Bank of England, Mervyn King, warned last night. After splits emerged between the US and parts of Europe last week on the need for rapid additional monetary and fiscal stimulus packages, Mr King's remarks will be taken as an implicit criticism of some European governments and his counterparts at the European Central Bank.

In his speech at the Mansion House, Mr King acknowledged failures in the UK's regulatory system, which he said had "lost focus". However, he also implied that "gullible investors" might take some of the blame for the financial traumas. Governments would, he added, have to inject "plain ordinary equity" to underpin the banks. In an apparent sideswipe at the FSA, he added: "A system in which it is easier for a large bank to expand and then destroy its balance sheet than for an individual to open a bank account has lost focus."

Mr King said that the G20 summit, to be hosted by Gordon Brown at Downing Street on 2 April, should agree a "joint commitment to a macroeconomic stimulus... to ensure a growth of nominal demand sufficient to reverse the extraordinarily steep and simultaneous downturn in output around the world."

"Without that collective commitment," added Mr King, "countries may neglect the beneficial effects that their policy actions can have on other countries, resulting in an excessively cautious approach."

Germany's fiscal stimuli of 4.2 per cent of GDP are similar in scale to President Barack Obama's $800bn stimulus package. However, unlike London and Washington, Berlin has sounded less enthusiastic about going further. During her visit to the UK last Saturday, the German Chancellor, Angela Merkel, warned: "If we want to actually strengthen the effect of such packages we will simply have to implement them first, and not already talk about the next to come."

Earlier, Mr King's German counterpart, Axel Weber, president of the Bundesbank, said: "The expectation that we could neutralise this synchronised recession through short-term fiscal policy measures is false. We should not even try. There will be costs."

Nor is there much agreement in European circles on the desirability of the Bank of England's "quantitative easing". Yesterday, the ECB president, Jean-Claude Trichet, refused to support it, while his fellow ECB executive committee member Juergen Stark, in effect the ECB's chief economist, said the time was not yet right for such a move.

As Lord Turner, the chairman of the FSA, prepares to unveil his report into financial regulation, Mr King raised the idea of a British version of the US Glass-Steagall Act, which separated retail and investment banking in America between 1933 and 1999. Mr King said there should be a "public and informed debate" on the subject, and reiterated his belief that "countercyclical" management of banks' capital positions would help to manage the credit cycle.