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London - The International Monetary Fund urged Britain to cool its housing market by reining in risky mortgages, the strongest warning yet from an international organisation about the risk of a property price bubble.
So far there have been few signs of a credit-driven bubble in British house prices, the IMF said.
But that could change fast and lenders should offer fewer mortgages that are far larger than borrowers' incomes, it warned in an annual report on Britain's economy published on Friday.
IMF managing director Christine Lagarde called on the Bank of England to use its powers over bank lending "early and in a gradual fashion as the first line of defence against risks ... from the housing market."
If efforts to rein in the market did not work the Bank of England would need to be ready to raise interest rates fast, the IMF said.
"Policy might ... have to be tightened quickly if costs run ahead of productivity growth, slack is absorbed, or financial stability concerns cannot otherwise be addressed," it said in the report.
British finance minister George Osborne, who spoke at the same news conference as Lagarde, said he would stay vigilant over housing, and that the BoE should not hesitate to act if needed.
Two major British banks, Lloyds Banking Group and Royal Bank of Scotland, have already said they will no longer lend at multiples of more than four times a borrower's income for mortgages of over £500 000 ($839 500).
With a national election due in less than a year, Osborne will be keen that the Bank of England does not take steps that will hurt growth or suggest his measures to revive housing demand were misguided.
House prices have risen by more than 11% over the past year according to one measure, the fastest rate since just before the financial crisis, powered by soaring London prices.
BoE Governor Mark Carney said in May that housing was the biggest threat to Britain's economic recovery. Later this month, the BoE could add to measures it has already taken to control the mortgage market.
The IMF said that more needed to be done now. "In an environment where expectations of capital gains can quickly drive up household indebtedness - and thus systemic risk for financial institutions - more policy action is warranted."
On Britain's economy more broadly, the IMF's tone was much more upbeat than a year ago when the country seemed to be on the verge of falling back into recession. Some officials at the Fund at the time said Osborne was too focused on cutting the budget deficit at the expense of growth.
Lagarde, who had a close working relationship with Osborne when she was France's finance minister, admitted the IMF had got it wrong. "I am happy to come back yet again and say that we had clearly underestimated the growth of the UK economy in our forecast a year ago," she said at the news conference.
Weak productivity was a risk to future growth, but overall Britain's fiscal stance was appropriate.
On housing measures, the IMF said a first step would be to limit the proportion of high loan-to-income mortgages any lender could issue. If that failed, the BoE should impose caps on loan-to-income and loan-to-value ratios, and increase the amount of capital lenders must hold against residential property loans.
The government might also need to stop offering mortgage guarantees under the Help to Buy programme if it sees much greater take-up. The scheme was launched by Osborne last year to help first-time homebuyers.
The IMF said that in the longer term, Britain had to build more houses. The opposition Labour Party said the report showed how the government's struggle to get more houses built meant interest rates might have to rise earlier than otherwise needed.
Andrew Sentance, a former BoE policymaker who has long called for tighter monetary policy, also said it was unclear how effective the BoE's so-called macroprudential tools to control bank lending would be in curbing house price risks.
"To a large extent these measures are untried and untested," he said. "If the first (interest rate) rise is delayed too long, there is a risk that the MPC will have to act quickly after the election with a succession of rapid rises."
