By Jason Douglas

LONDON--The Bank of England may need to lift interest rates at a faster pace than expected if inflation in the U.K. takes off or new regulations prove ineffective at reining in a booming housing market, the International Monetary Fund said Monday.

In its annual health-check of the U.K. economy, the IMF said the BOE's ultra-loose policy stance is for the moment appropriate but added it "might need to be adjusted quickly" if inflationary pressures intensify. The fund said rate rises may also be needed to cool the housing market if recent attempts to cap riskier lending fall flat.

The BOE is expected to be the first of the world's major central banks to call time on crisis-era policies and begin raising interest rates early next year. The U.S. Federal Reserve is expected to follow suit in mid-2015.

BOE officials have said they intend to raise rates slowly to provide support to the economy. They have also signaled rates are unlikely to return to their precrisis average of 5% any time soon. Officials say 2.5% or 3% will likely be as high as their benchmark rate goes for the next few years.

The IMF's assessment highlights a risk facing central banks as they chart their exit from years of ultra-loose policy--that tightening too slowly allows inflation to take hold and could require a more aggressive tightening than central bank officials would like, which could slam the brakes on a fragile global recovery.

The fund's report notes, for example, that some heavily indebted British households could be vulnerable to a steep rise in borrowing costs, which could hurt consumer spending, the engine of economic growth in the U.K.

The IMF's report isbroadly positive. The fund predicts the U.K. economy will expand 3.2% in 2014, the fastest pace of growth among its advanced-economy peers, including the U.S., France and Germany. Fast growth and low inflation--the annual rate of inflation was 1.9% in June, beneath the BOE's 2% target--are forecast to persist.

But the fund highlighted some risks to the recovery, including weak productivity and a shaky international outlook.

"The global economy could see further disruptions arising from the withdrawal of unconventional monetary policies in the U.S., a sharp slowdown of growth in the euro area and across key emerging economies, and increases in geopolitical tensions," the IMF said.

It added that officials may need to take broader action to tackle an incipient housing boom, including building more homes. A bigger challenge is narrowing the U.K.'s persistent current-account deficit, the fund said. It said it estimates sterling is overvalued by anywhere between 5% and 10%, which could be sapping demand for British exports.

In all, the fund said the "immediate challenge" to policy makers in Britain is to "ensure that strong growth persists, without creating inflationary pressures or financial stability risks."

Write to Jason Douglas at jason.douglas@wsj.com

(END) Dow Jones Newswires

July 28, 2014 10:14 ET (14:14 GMT)

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