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LONDON (Reuters) - The Bank of England moved to head off the risk of a housing bubble in Britain on Thursday, making a surprise announcement that it would put the brakes on a scheme launched last year to help boost mortgage lending.
The central bank said the Funding for Lending Scheme (FLS) would cease to offer banks incentives for mortgage lending and instead be refocused on helping small firms to borrow. The news caused shares in house-building firms to tumble.
Britain's economy and its housing market have staged an unexpectedly strong turnaround since the FLS was launched by the BoE and finance ministry in July 2012 in an effort to spur the long-delayed recovery by unblocking credit markets.
"Given the access to credit for households now ... it would no longer be appropriate or necessary for us to have our foot on the accelerator. It's better to shift into neutral," BoE Governor Mark Carney said.
Another - much-criticized - government program to aid the housing market, Help to Buy, remains in place.
British house prices have risen by almost 7 percent over the past 12 months - their fastest growth in more than three years - sparking concern about the risk of a future bubble as well as rising living costs at a time of stagnant wages.
London prices have surged even more, partly on the back of foreign demand, and finance minister George Osborne is widely expected to introduce a capital gains tax on foreign-owned property in a half-yearly budget update next week.
"We did not see an immediate threat coming from the housing market but we are concerned about the prospective evolution of the housing market," Carney said, adding that the BoE could take further steps to rein in house prices if needed.
Osborne, who has made a revival of Britain's housing market a key part of his economic plans, endorsed the decision.
Sterling hit a 14-month high as currency traders bet the news moved the BoE closer to raising interest rates from a record low of 0.5 percent, where they have been since 2009.
Economists disagreed, saying tighter regulation could reduce the need for the BoE to raise rates to tame house prices. "By taking such action it can actually limit the need for direct monetary policy tightening," said James Knightley at ING.
House-building firms at one point lost more than 1 billion pounds ($1.63 billion) in market value as their shares - which have more than doubled in two years, helped by efforts to kick-start the property market - fell heavily on the news.
Carney said he did not expect a big economic impact because market funding conditions had improved over the past year and banks were already making limited use of the FLS.
"Although the changes to the FLS may be a surprise, they are not a shock," said Paul Smee, who heads the Council of Mortgage Lenders, an industry group. "Lenders are well equipped to meet their funding needs, as wholesale funding market conditions have improved and retail deposits are robust."
Banking analysts at Bernstein Research warned that over the longer run the change could push up mortgage rates, as the FLS had boosted competition in Britain's mortgage market.
The news raised questions about how the BoE will judge another, more controversial housing scheme. Help to Buy, which was expanded last month by the government, aids home-buyers who lack the large deposits sought by mortgage lenders since the financial crisis.
That plan has been widely criticized by economists and the opposition Labour Party for doing too little to boost house-building and for risking a surge in prices.
The BoE is due to review Help to Buy in September, and Carney said on Thursday it could make recommendations sooner if it felt the scheme threatened financial stability.
Under the FLS, banks and building societies get cheap credit from the BoE in proportion to how much they raise their lending.
Thursday's changes mean banks will be unable to claim the cheap funding for new lending to households from January 1, 2014. Fees charged to banks for business finance would be reduced to the lowest point on the existing scale, 0.25 percent.
Favorable capital treatment for new home loans made under the FLS will end on December 31. Five, mainly small, lenders benefit from this at present.
Carney said the BoE would take more action to cool housing if needed, including a possible cap on how big mortgages can be relative to property values and borrowers' salaries. The BoE lacks powers to force banks to follow such recommendations, but it can require banks to hold more capital against risky lending.
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. ($1 = 0.6144 British pounds)
Editing by William Schomberg, Guy Faulconbridge and Catherine Evans