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UPDATE 2-Bank of England cuts mortgage support to avoid housing bubble

David Milliken and Huw Jones
Thursday, 28 Nov 2013 | 7:55 AM ET

* BoE refocuses Funding for Lending squarely on small firms

* Carney says see no risk now from housing

* Pound rises, house-building stocks fall

LONDON, Nov 28 (Reuters) - The Bank of England moved to head off the risk of a bubble in house prices on Thursday, making a surprise announcement that it would put the brakes on a scheme launched last year to boost mortgage lending.

Shares in British construction firms tumbled after the central bank said it would refocus the Funding for Lending Scheme (FLS) on helping small firms that find it hard to borrow.

Britain's economy and its housing market have staged an unexpectedly strong turnaround since FLS was launched by the BoE and finance ministry in July 2012 to spur lending to home-buyers and businesses.

Another, much-criticised, government programme to aid the housing market, Help to Buy, remains in place.

"We did not see an immediate threat coming from the housing market but we are concerned about the prospective evolution of the housing market," BoE Governor Mark Carney said.

"The concern is where this could go. We definitely see some short-term momentum," he said, adding the BoE was prepared to take "larger measures" to tame rising house prices if needed.

Carney said it would "no longer be appropriate or necessary for us to have our foot on the accelerator" in terms of spurring mortgage lending. "It's better to shift into neutral."

Sterling rose after the announcement, while construction firms lost more than 1 billion pounds ($1.63 billion) in value. Barratt Developments, Britain's biggest housebuilder by volume, saw its shares slump by as much as 9.6 percent.

Finance minister George Osborne said he backed the changes to the FLS scheme.

British house prices are likely to rise nearly 6 percent in 2014 on top of a similar a increase this year, according to a Reuters poll of economists published earlier this week.

James Knightley, an economist with ING, said the shift in policy was not a precursor to an interest rate hike by the BoE, which has kept borrowing costs at a record low since 2009.

"Such measures have been undertaken elsewhere, and there the sense is that by taking such action it can actually limit the need for direct monetary policy tightening," Knightley said.

A representative of British mortgage lenders said the industry was well placed to cope without the scheme's support.

"Although the changes to the FLS may be a surprise, they are not a shock. Mortgage lenders are well equipped to meet their funding needs, as wholesale funding market conditions have improved and retail deposits are robust," said Paul Smee, director general of the Council of Mortgage Lenders.

Carney said the changes to the FLS did not have implications for Help to Buy, which aims to lift construction and aid home-buyers without large mortgage deposits, and which the BoE will review next September.

CONCERNS ABOUT CREDIT

Earlier this week Carney faced questions from lawmakers worried that a house price bubble is forming, and that a lack of lending to small firms is hampering Britain's economic recovery.

"We should refocus the FLS so that it continues to support lending to the business sector, without adding further broad support to household lending at a time when that is no longer necessary," Carney said in a letter to Osborne.

Economic growth in the three months to September was the fastest in three years, banks have far easier access to finance, and house prices are rising at their fastest for three years.

Most of the increase in house prices has been concentrated in London and nearby areas, but Carney said price rises now seem to be spreading more broadly across the country.

Under the FLS, banks and building societies can access cheap credit from the BoE in proportion to how much they lift lending.

On Thursday, the BoE said banks would not be able to claim the cheap funding for new lending to households from Jan. 1, 2014, although existing entitlements would not be affected. Fees charged to banks for business finance would be reduced to the lowest point on the existing scale, 0.25 percent.

The BoE also said that favourable capital treatment for new home loans made under the FLS would end on Dec. 31. Five, mainly small, lenders benefit from this at present.

Carney also said he was ready to take further action to cool housing if need be, including recommending a cap on how big mortgages can be relative to property values and borrowers' salaries.

Currently the BoE lacks the power to force banks to follow its recommendations on such caps, but it could instead require banks to hold extra capital against risky lending - another option that it outlined.

Away from housing, the BoE said a stronger economic outlook meant that risks to financial stability appeared lower.

Risks remained, however, as many countries, firms and individuals were highly indebted and vulnerable if a sharp rise in interest rates outpaced any increase in their incomes.