ANALYSIS-Bank of England to take early but cautious action on UK housing market


* BoE says would be dangerous to ignore booming house prices

* Key committee meets next month to decide changes

* Tighter mortgage rules, higher capital charges in view

* Impact of new tools uncertain, rate rise not yet an option

LONDON, May 2 (Reuters) - The Bank of England's starkest warning so far about Britain's booming house prices is likely to be followed by cautious measures, possibly as soon as next month, as policymakers test out their new powers.

Deputy Governor Jon Cunliffe told bankers late on Thursday that it would be "dangerous" to ignore the rapid rise in house prices, which are up nearly 11 percent over the past year - the kind of increase last seen on the eve of the financial crisis.

Two other senior BoE officials expressed similar worries when quizzed on Wednesday by lawmakers.

The focus is squarely on the June 17 meeting of the central bank's Financial Policy Committee, which was set up to prevent a repeat of the kind of recklessness in the banking sector that helped push Britain into a damaging recession.

A year ago, the FPC gained sweeping but largely untried powers to curb excesses in the financial sector.

One option that has been ruled out for now is a rise in interest rates by the BoE, which does not want to derail a recovery that is more fragile in other parts of the economy.

Instead, the Bank, via the FPC, may require banks to check that new borrowers could cope with much higher interest rates; make banks hold more capital against certain types of mortgages; or urge caps on how large mortgages can be compared to a borrower's income.

The country has a history of boom and bust in its housing market, and while Switzerland, New Zealand, Sweden and others have also taken steps to cool property prices, Britain will be the largest economy to do so thus far.

As the Bank of England gets to grips with its new 'macroprudential' tools, it probably wants to start gradually, and one piece of data released by the BoE on Thursday helps explain why. Mortgage approvals in March sank to a six-month low, having hit their highest level since late 2007 in January.

Banks were already starting to implement rules which came into force last week requiring them to make much more detailed checks on prospective borrowers' income and spending than before the crisis.

"In effect we saw an interest rate increase last weekend with the mortgage market reforms," said Andrew Milligan, head of strategy at Standard Life Investments which manages 184 billion pounds ($311 billion) of funds, including 10 billion in property.

Banks now need to spend around two hours interviewing each mortgage applicant - far longer than was common before - likely creating a bottleneck in approvals as well as restricting the number of eligible borrowers, he said.

But the scale of the impact is something that neither Milligan nor the BoE can judge easily.

This means the central bank is likely to want to take more action soon to stop the housing market running away with itself, but of a relatively limited scale so that it can get a sense of the impact of its new tools.

"The BoE is unlikely to stamp a size-10 boot down on the housing market," said Rob Wood, chief UK economist at Berenberg. "If the central bank does not know how powerful its tools are, it is unlikely to start with them on full power. Rather, it will gradually ratchet up the pressure."

Prices outside London are still several percent below pre-crisis peaks, even before adjusting for inflation, and transaction levels have not recovered either.

Macroprudential measures also will not solve Britain's underlying shortage of new homes.


The BoE is acting as a trail-blazer for other major central banks, which see the need to keep a grip on lending as one of the lessons of the financial crisis.

The European Central Bank is slowly getting drawn into bank regulation as the euro zone creates a banking union. Regulatory responsibilities in the United States are spread across many more bodies than just the Federal Reserve.

In setting policy, the BoE is likely to look past eye-catching headlines such as Friday's news that a single apartment in London sold for a record 140 million pounds.

It is less worried about cash purchases in central London by the world's super-rich than about preventing a rapid growth in the exposure of British lenders to mortgages, which in a worst-case scneario could put at risk banks' ability to lend to businesses and require further taxpayer bailouts.

For now, net mortgage lending growth has been modest - at around 1.5 percent a year. A 40 percent rise in gross lending has been largely cancelled out by mortgage repayments.

The central bank's preferred outcome would be for affordability constraints to cause house price growth to level off, and for prices to rise in the long run at a level close to earnings growth - which has averaged 5 percent in the past.

But looser mortgage lending standards could extend the recent run-up in prices, so one of the steps the BoE is most likely to take in June would be to make banks ensure that borrowers can afford a rise in mortgage rates greater than the 3.5 percentage points required now.

Another would be to limit the proportion of high loan-to-value mortgages on banks' books, or further increase capital requirements as insurance against loans going bad.

Further down the line, the BoE is due to review in September whether the government should maintain the part of its Help to Buy scheme that boosts access to high loan-to-value mortgages.

Graham Beale, chief executive of Nationwide, one of Britain's largest mortgage lenders, told Reuters that these measures may not work.

"Most of what they have got is blunt and will bypass a lot of the cash transactions," he said.

Larger capital charges on banks would help dampen the housing market, but it is unclear if it would be quick enough, Beale said. "It would have to be quite large and severe to influence things." ($1 = 0.5919 British Pounds)

(Editing by William Schomberg and Hugh Lawson)