The Bank of England underestimated the severity of the current financial crisis, according to its deputy governor, who has admitted that interest rates are only a "blunt instrument" with which to control the economy.

Sir John Gieve told the BBC's Panorama programme, to be screened tonight, that new tools were needed to complement interest rates. He also admitted that the Bank knew "crazy borrowing" was taking place and the price of houses and other assets was rising unsustainably, but did not fully understand the problem.

"We didn't think it was going to be anything like as severe as it's turned out to be," said Gieve, who is in charge of financial stability at the Bank. "Why didn't we see that it was so serious? I think that's because we, perhaps, we hadn't kept pace with the extent of globalisation. So the upswing here didn't involve the big increases in earnings and consumption and activity which we saw in previous booms. We saw the credit, we saw the house prices, but we did see a fairly stable pattern of earnings, prices and output."

Tim Besley, another member of the Bank's monetary policy committee, was quoted in the Daily Mail as saying there was "no quick or easy fix" to deal with the fall-out from the credit crunch and that measures other than monetary policy were needed.

Sterling fell to a fresh record low against a trade-weighted basket of major currencies after the comments, hit by worries that British interest rates need to come down much further as recession bites. The euro climbed 1.5% to 94.72p, taking it close to its recent record high of 95.56p, which has led to the expectation that the two currencies will soon reach parity.

More powers needed

Explaining why the Bank did not raise interest rates to curb the lending and house price boom, Gieve said: "If we'd used interest rates to try and address this asset-price credit growth, we would have been holding down the level of activity elsewhere in the economy, in manufacturing, in other services, holding down the level of employment at a time when consumer price inflation and earnings were stable and reasonably low. And people would have said, you know, 'this is a wilful reduction in the prosperity of the country'."

The Bank could not rely only on interest rates to control the economy, Gieve argued. "One of the main lessons from this is that we need to develop some new instruments which sit somewhere between interest rates, which affect the whole economy and activity, and individual supervision and regulation of individual banks," he said.

"Maybe we need to develop something which bridges that gap and directly addresses the financial cycle and prevents the financial cycle and the credit cycle getting out of hand... I think we need to complement interest rates, which are a blunt instrument – you set one interest rate for the whole economy – with something which is more financial-sector specific."

Philip Shaw, chief economist at Investec, said the comments suggested that the "authorities recognise that more needs to be done to restrain borrowing booms because they are potentially destabilising." He noted that there had been numerous comments by Bank officials previously stating that interest rates could not be used to rein in borrowing because they were mainly designed to keep inflation on target.

Among the measures being considered by the government – to be adopted once the economy recovers – is a requirement for banks to hold more capital during good times. Other measures could include legislation or guidelines on lending to households, Shaw said.

Gieve defended the Bank's performance in the crisis, which he called "a major storm we haven't seen the like of for 100 years".

"It would be very surprising if we weren't learning lessons from it and we are," he added.

Gieve also cast doubt on whether the Treasury would get all of the money back that it had poured into the banking sector, pointing to a "level of defaults" in the books of nationalised lenders Northern Rock and Bradford & Bingley, which were now held by the taxpayer.

Speaking on the same programme, John Varley, the chief executive of Barclays, predicted that consumers and businesses would struggle to get access to credit for the next one to two years.