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UPDATE 1-Monetary policy not best financial stability tool - Yellen

(Adds quotes from Yellen speech, details)

WASHINGTON, July 2 (Reuters) - Monetary policy faces "significant limitations" as a tool to address financial stability risks, and would have caused major economic damage if it had been used to head off the U.S. housing bubble, Federal Reserve Chair Janet Yellen said on Wednesday.

Weighing in a global central banking debate, Yellen reiterated her view that regulatory policy needs to play the lead role in combating excessive financial risk-taking.

She said, however, that an increased focus on financial stability in monetary policy deliberations was appropriate, but that central banks should only shift interest rates to combat risks to stability in rare circumstances.

"The potential cost ... is likely to be too great to give financial stability risks a central role in monetary policy discussions," Yellen said at an event sponsored by the International Monetary Fund.

The U.S. stock and bond markets have soared on the back of the Fed's extremely accommodative monetary policy, prompting warnings from some analysts and economists that new bubbles may be forming.

Yellen played down those concerns.

"I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment," she said.

Last month, the IMF cut its growth forecast for the United States and said the economy would not reach full employment until the end of 2017, allowing interest rates to be held near zero for longer than financial markets expect.

It also warned, however, of financial stability risks as the prolonged period of ultra-low interest rates has prompted weak lending standards and risky behavior by investors.

"It is ... important that we monitor the degree to which the macroprudential steps we have taken have built sufficient resilience," Yellen said.

Yellen said she saw pockets of increased risk-taking across the financial system that could warrant a more "robust macroprudential approach" if those concerns grew.

She cited low volatility and corporate bond spreads, as well as weak lending standards in parts of the leveraged-loan market.

She added that she does not see a systemic threat from leveraged lending, and that data does not suggest that non-financial borrowers are taking on excessive debt.

(Reporting by Michael Flaherty and Howard Schneider; Editing by Paul Simao)