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LONDON (Reuters) - Bank of England Governor Mark Carney said on Thursday that British interest rates could rise sooner than financial markets expect, in a surprisingly stark warning that monetary policy may start to tighten within months.
Speaking alongside British finance minister George Osborne, Carney also said the central bank would carefully weigh the merits next week of tackling housing market risks, including an undesirable loosening in mortgage underwriting standards.
Earlier on Thursday, Osborne said he would grant the BoE new powers to impose maximum loan-to-value and loan-to-income ratios on mortgage lending, which Carney welcomed in his speech to London's financial community.
However, Carney's comments on the possible timing of an interest rate rise are the most striking. Relatively few economists had expected rates to increase until the second quarter of next year.
Carney said Britain's economy still had scope to grow without pushing up inflation, but that there was little sign yet of a slowdown in the pace of expansion that the central bank had pencilled in for the second half of the year.
"There's already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced," he said. "It could happen sooner than markets currently expect."
Sterling gained a cent against the U.S. dollar to hit a one-month high above $1.693 as traders bet on a rate rise that some thought could now come before the end of the year.
"Not only did sterling react, but it reacted pretty quickly and ... much more strongly than people would have considered," said Lane Newman, director of foreign exchange at ING Capital Markets in New York.
Last month, a minority of BoE policymakers said the case for a rate rise was "more balanced" and that interest rates might need to increase sooner rather than later to ensure they did not need to rise sharply.
But Carney had until now appeared less keen to contemplate a rate rise, emphasising that Britain's economy was still a long way from full strength.
On Thursday, Carney said that more important than the timing of a first rate rise was that future increases be "gradual and limited", in part due to high household indebtedness and a drag on growth from a stronger currency.
He also said that the timing of a rate rise would depend on incoming data, and that the BoE had no fixed plan on when to raise rates.
Britain's record current account balance was not an immediate cause for alarm, he added, but it was only sustainable to borrow from abroad to fund investment, not consumption.
"Excessive reliance on consumption or non-tradable sectors, such as housing, all financed by borrowing abroad at an over-valued exchange rate, would prove only temporarily satisfying," he said.
Carney said he was also concerned by signs that mortgage lending standards were becoming looser and set out the case for early action as insurance against future risks by the BoE's Financial Policy Committee, which meets next week.
He welcomed Osborne's plan for the BoE to lead a new review into unethical behaviour in financial markets, with a view to making a wider range of misconduct subject to criminal penalties.
But he also said it was important that the central bank supported markets where needed. Within the next year, he said, major British brokers would be able to access BoE facilities on similar terms to banks.
The BoE would also consider expanding its capacity to lend in currencies other than sterling, he added.
Additonal reporting by Sam Forgione in NEW YORK; Editing by Larry King and Jonathan Oatis