Governor of the Bank of England Mervyn King has used the launch of the Bank's inflation report to talk about the "paradox of policy" in the UK's finances, and how the services sector is at the heart of the economy.

Speaking this morning in the City, King said that increasing the supply of money in the UK meant adopting policies that would in normal circumstances damage the economy – the paradox of the times in which we live.

King said that the UK economy will shrink by four percent in 2009 if interest rates stay at their current level, and inflation will fall to 0.5 percent in two years. This puts into sharp relief his comments in 2008 that the UK economy "needed" to slow down.

World trade shrunk by 10% in the final quarter of calendar 2008, said King.

There is a fault line in the international money markets, said King, who claimed that the Bank had for a long time been pointing this out. However, this does not explain why the downturn, when it came, seemed such a surprise to the UK's financial sector.

"I'm not paid to forecast the future," he said in response to a question about the unexpected "shock" of the downturn.

The UK is now in "a deep recession", he said, and a further easing of monetary policy is needed. This may mean a shift towards quantitative easing – the modern version of printing money.

King said this may be discussed at a future meeting, and that interests rates did not need to fall to zero for it to be considered.

Of the falling interest rate, King said that savers were not responsible for the credit crunch, but no one seriously believed that raising interest rates to increase the value of people's savings would help the UK economy.

In future, new policy instruments should curb explosve growth in the financial sector, said King, who emphasised that there is no reason why high unemployment should be the price of poorly regulated financial services.

New figures released this morning put unemployment at 1.97 million.

Despite all the bad news, King said there was reason for optimism and the international bailout packages designed to increase liquidity and the credit supply "will work". The results, however, may not be seen until next year.

It seems, then, that King is attempting a public double-header: saying that he saw the flood but, Canute like, was surprised it did not recede when he put up his hand to stop it.

There is also a worrying double-speak in today's discussions about the bailout packages in the banking sector. These were specifically designed to ease the logjam of credit in the short term; now King is saying up to 18 months may pass before we see real change.

The fact remains, however, that if banks can supply no credit, then they have no role.

The modern banking culture is surely to blame: we value debt more highly than good sense: customers with dozens of maxed-out credit cards score more highly than people with a healthy bank balance and zero debt. High street banks have begun to see themselves as high stakes dealers – like the Masters of the Universe in Bonfire of the Vanities – not as custodians of the public's purse.

• Sir James Crosby has resigned as deputy chairman of the FSA, after yesterday's revelations in front of the Select Committee concerning the sacking at HBOS of Paul Moore, a risk management official who says he warned the bank that it was fatally exposed and taking on too much risk.

It has emerged that Crosby sacked the official in person. HBOS has said today that the sacked official's allegations have "no merit", in an attempt to deny board-level culpability for the high levels of risk in the banking sector.

Sir James Crosby has been one of Gordon Brown's closest and most trusted economic advisors.