Analysis - Mortgage controls no panacea for UK housing risks

By Ana Nicolaci da Costa LONDON (Reuters) - The Bank of England wants to avoid resorting to higher interest rates to cool Britain's housing market, but the pace at which prices are climbing and the experience of other countries suggest it might not manage to delay for very long. Canada and New Zealand have used targeted measures to tighten their grip on mortgage lending and take some of the heat out of their property markets. In the end, though, both central banks had to raise borrowing costs too. Given that Britain is expected to take a more cautious approach to curb lending, it may find it harder to contain the housing sector without bringing forward the point at which it raises interest rates from a record low 0.5 percent. The BoE has signalled it wants to start raising rates only next year for fear of derailing economic recovery though minutes of its last meeting, released on Wednesday, showed some of its policymakers think the case for tightening is becoming stronger. At the same time, the Bank has sounded increasingly worried about housing. Governor Mark Carney says it poses the biggest risk to the recovery while stressing that interest rates are not the first line of defence. That job falls to the Bank's Financial Policy Committee which was created to avoid a repeat of the kind of banking excesses that sent Britain into recession five years ago. It has already taken some measures to cool housing and is expected to tread carefully when it meets next month given its powers are largely untested. Options open to the FPC include making banks hold more capital against certain types of home loans or urging caps on how large mortgages can be compared to a borrower's income. "It's highly possible that just dipping your toe in the water isn't enough," said Simon Wells, an economist at HSBC. Central banks seem to be most effective when they impact home-buyers directly rather than via restrictions on lenders with so-called macroprudential measures. "Those tend to have the greatest effect," Wells said. Complicating the picture in Britain are big regional differences behind national house price growth of about 10 percent. In the 12 months to March, prices in London surged 17 percent, pushed up by cash-rich foreign investors. To cool demand in the capital, the government will make foreign investors in British property pay capital gains tax from 2015. What the BoE decides to do will be followed closely by Prime Minister David Cameron who is facing national elections in May next year. Ongoing house price inflation is seen as a factor likely to add to support for his Conservative party. LESSONS TO LEARN? When Canada and New Zealand turned to macroprudential measures to control housing, they took a tough approach. Canada tightened mortgage rules for borrowers with small deposits several times between 2008 and 2012, including limits on the size of mortgages in relation to property values and reducing amortization periods. The changes helped it avoid a U.S.-style housing crash but they were carried out over a long period of time during which the central bank - then headed by Carney - also tightened monetary policy. The combination of tighter mortgage controls and higher borrowing costs still may not turn off prospective buyers, who have benefited from sharp rises in house prices in recent years. Nominal house prices in Canada have jumped nearly 30 percent since early 2009, according to Goldman Sachs. "As long as interest rates remain low, nothing will prevent the housing market from continuing to expand," said Benjamin Tal, an economist at Canadian Imperial Bank of Commerce. In New Zealand, temporary restrictions to high loan-to-value residential mortgages were introduced last year. But the central bank there has raised interest rates by 50 basis points so far this year as it tries to tackle inflation pressures from an economy buoyed partly by a booming housing market as well as from reconstruction after an earthquake. The bank has said while the macroprudential measures have helped slow house price inflation, credit growth and risk, house prices remain high and overvalued in some places. BABY STEPS British policymakers are expected to start with measures that have a less direct impact on borrowing, such as forcing banks to hold more capital against home loans or by toughening up new rules aimed at ensuring borrowers can afford the loans they are taking on. Since April, mortgage lenders have been required to make stricter checks on a borrower's ability to repay, which at least slows the process of giving loans. Another option would be for the FPC to call on the government to lower the ceiling for properties qualifying for its "Help to Buy" mortgage guarantee plan. That would have greatest impact on the pricey London market. Cameron said he was prepared to pare back the government scheme, which allows people to buy homes worth up to 600,000 pounds with just a 5 percent deposit, if Carney advised it. And on Tuesday, British bank Lloyds jumped ahead of the pack, announcing it would limit mortgages to a maximum of four times a borrower's annual earnings when it is lending more than 500,000 pounds on a property. But the lesson from elsewhere is that these measures tend to work in conjunction with monetary policy, not as a substitute. "They are still optimistic that a bit of tough talk and a little bit of action around the edges will be enough," said Ed Stansfield, chief property economist at Capital Economics. "I think the lesson internationally is you cannot assume that macro-prudential policies on their own are the be-all and end-all of controlling lending behaviour," he said. "They are not a substitute for conventional forms of monetary policy." In the end, measure may be needed to tackle supply as well as demand. Carney notes that his native Canada builds twice as many homes as Britain with only half the population. A Reuters poll of economists last week predicted the Bank would act soon but even so house prices would rise nearly 8 percent this year as a dearth of supply and the government loan programme fuel inflation. (Additional Reporting by Louise Egan in Ottawa and Naomi Tajitsu in Wellington. Editing by William Schomberg/Mike Peacock)