* Tucker: Recovery's strength unlikely clear until summer'10
* Worst case scenario of depression now unlikely
* Question now if some QE "catastrophe insurance" can go
* Banks should not be "too interconnected" to fail
* Cyclical capital rules could have perverse effects
(Adds more on regulation)
By David Milliken and Christina Fincher
LONDON, Oct 22 (Reuters) - Britain faces the risk of anaemic economic growth as it comes out of recession, and the recovery's strength will be unclear until next summer, Bank of England deputy governor Paul Tucker said on Thursday.
A worst-case scenario of economic disaster has probably been avoided, but it is too early to tell whether inflation might undershoot its target because of a period of weak growth, Tucker told London financiers in a speech.
"One of the biggest questions is whether, given the policy stimulus, recovery will be anaemic or whether we can attain the above-trend growth needed to absorb the slack in the economy necessary to ameliorate downward pressures on inflation," he said.
Tucker said this question would dominate November's quarterly revision to the central bank's growth and inflation forecasts.
"I fear, however, that we may not be much clearer about the general trends in demand until at least late spring or early summer next year," he said.
But the BoE will have to make a decision about the future of its 175 billion pound quantitative easing programme before then, as the last of the existing funds allocated for gilt purchases will be spent next week.
Tucker said the scale of that programme had in part been based on avoiding an economic doomsday scenario, the likelihood of which was now receding.
"The stage where the most hideous macroeconomic nightmare -- a second Great Depression revisited -- is now probably remote," he said. "The size of the massive monetary stimulus has partly been designed to insure against that catastrophe risk."
"So a key question over the coming period will be whether or not conditions are developing where some of that insurance could be withdrawn, consistent with leaving policy highly stimulative."
Most economists expect Britain to have emerged from recession in the third quarter after more than a year in decline.
But weak industrial output and retail sales figures have raised doubts among some that GDP data, to be released on Friday and which economists expect to show a 0.2 percent quarterly increase, may turn out weaker than expected.
"SOCIAL JUSTICE"
Tucker fleshed out calls for tougher regulation of banks made by BoE Governor Mervyn King in a keynote speech earlier this week and said it was a matter of social justice.
"It just cannot be acceptable that the downside from excessive risk across the financial system as a whole falls to the general taxpayer, to households and firms throughout the economy, if the upside is enjoyed by a narrower group of shareholders and managers," Tucker said.
"This is not just an issue of economic efficiency -- of the allocation of resources -- and of leaning against the risk of even bigger crises down the road, but also of social justice."
Policymakers have differed publicly over how to regulate banks, with Prime Minister Gordon Brown opposing proposals mooted by King to split banks' investment and retail divisions.
Earlier this week, King said banks should not be allowed to become so large that they cannot be allowed to fail and suggested separating core aspects of banking from riskier activities to reduce the risk of a bank failure jeopardising the financial system. [ID:nLAG003852]
Tucker stressed the need for better cross-border coordination and said it was not just a question of whether banks were "too big" to fail, but whether they were "too interconnected" or "too complex" to fail.
"Banks need a system in which they are better protected against mismanagement by their peers," he said.
Tucker said monetary policy alone was not enough to prevent asset bubbles forming, and also cast doubt on the popular suggestion that headline capital requirements should vary through the credit cycle.
Perversely, this could reduce lending to areas where credit was far from plentiful, while allowing credit to still to flow to parts of the economy that were already overheated, he said.
"Quite often a credit boom is at least initially concentrated in one or a few sectors of the economy," Tucker said. "That being so, the approprate instrument needs to be able to work with a degree of granularity."
Changing capital-risk weights on exposures to particular classes of borrower, and varying mimimum collateral haircuts on secured lending were two options, but neither was straightforward.
The BoE would publish a more detailed discussion paper on this in the next few weeks, Tucker added. * For a text of the speech, see http://www.bankofengland.co.uk/publications/news/2009/079.htm