Boris Johnson has said he will announce plans today for "fundamental changes to the system for dealing with those convicted of terrorism offences" following a terror attack in south London.
Two people were stabbed in the attack which police believe to be "Islamist-related".
Scotland Yard said armed officers shot dead a man as part of a "proactive Counter Terrorism operation" on Streatham High Road that unfolded at 2pm yesterday.
He has been named as Sudesh Amman, and he is believed to have been released from prison halfway through his sentence as recently as a week ago after serving time for 13 terror offences.
Whitehall sources told The Daily Telegraph that "there was nothing that could be done to keep him locked behind bars".
It has been reported that he was under active counter terrorism surveillance.
Alexis Boon, former head of the Metropolitan Police Counter Terrorism Command, told The Telegraph that at the time of his conviction Amman had a "fierce interest in violence and martyrdom".
Three victims were taken to a south London hospital, with one man's condition said to be life-threatening and one woman being treated for non-life threatening injuries.
Police said a second woman received minor injuries believed to have been caused by glass following the discharge of a police firearm.
A device found strapped to the body of the suspect was a hoax, the Metropolitan Police added in a statement.
It said: "The situation has been contained and officers from the Met's Counter Terrorism Command are now leading an investigation into the incident.
"The incident was quickly declared as a terrorist incident and we believe it to be Islamist-related."
After paying tribute to the police, the Prime Minister said that after the "awful events at Fishmonger's Hall" in London in December - when an Islamist extremist out of jail on licence killed two people - "we have moved quickly to introduce a package of measures to strengthen every element of our response to terrorism - including longer prison sentences and more money for the police".
"Tomorrow, we will announce further plans for fundamental changes to the system for dealing with those convicted of terrorism offences," he added.
One witness described seeing the man apparently carrying a weapon with "silver canisters on his chest" being shot in front of a Boots store.
Another said members of the public came to the aid of victims, with one saying she had been stabbed.
People took shelter in nearby shops as the incident unfolded on the busy high street.
A 19-year-old student from Streatham, who did not want to be named, said: "I was crossing the road when I saw a man with a machete and silver canisters on his chest being chased by what I assume was an undercover police officer, as they were in civilian clothing. The man was then shot. I think I heard three gunshots but I can't quite remember.
"After that, I ran into the library to get to safety. From the library, I saw a load of ambulances and armed police officers arrive on the scene."