April 30 (Bloomberg) -- The Bank of England, confronting a record-breaking real-estate boom, is finding there's more to monetary policy than just keeping consumer prices in check.

A decade after the central bank won its independence from government control, surging U.K. property values are throwing into question the inflation-targeting approach of Governor Mervyn King and his colleagues, which focuses on consumer prices as the lodestar of policy and gives lower priority to asset values, money supply and credit growth.

The bank's approach isn't broad enough to tackle asset bubbles that can burst and lead to recessions, says Tim Drayson, an economist at ABN Amro Holding NV in London who formerly worked at the U.K. Treasury.

``In a few years' time, people will find that inflation- targeting is flawed,'' he says. ``The Bank of England's inflation focus has been too narrow. It's too late to engineer a soft landing now.'' The criticism of the bank, which was among the first to adopt a target, comes as U.S. Federal Reserve Chairman Ben S. Bernanke and other central bankers consider setting their own inflation goals.

The International Monetary Fund calls overvalued home prices one of the most significant risks to the U.K. economy, and some private economists warn that a collapse in values could hurt consumer spending and weaken bank balance sheets.

Embraced

At stake is the reliability of a policy pioneered by the Reserve Bank of New Zealand in 1990, embraced two years later in the U.K. and since adopted by more than 20 other central banks.

Inflation-targeting means monetary authorities set a numerical goal, using a time horizon of about two years. That contrasts with the practice at the European Central Bank, where President Jean-Claude Trichet advocates paying more attention to gauges such as credit growth and money supply, in addition to consumer prices.

The Bank of England, which celebrates 10 years of independence on May 6, has won plaudits for anchoring price expectations in an economy plagued by runaway inflation in the decades after World War II.

The economy has expanded for 39 straight quarters since the bank took over rate policy from the Treasury, enabling it to pursue its targeting strategy unfettered.

Inflation Goal

The bank's goal is inflation of 2 percent, and it has kept average gains in consumer prices at 1.5 percent since 1997, compared with 4.2 percent in the previous eight years.

While that allowed King, 59, to slash interest rates to the lowest levels since the 1950s, he now faces what Claudio Borio, head of policy analysis at the Bank for International Settlements in Basel, Switzerland, calls a ``paradox of credibility'': The more a central bank succeeds in keeping prices stable, the more likely that signs of an overheating economy will show up first in asset bubbles.

As in the U.S., a combination of stable inflation and low interest rates triggered a real-estate boom in the U.K., where house prices have tripled in the past decade. In the last year alone, London values jumped 16 percent, reports HBOS Plc, the U.K.'s biggest mortgage lender.

At 200,000 pounds ($398,000), a parking space in London's affluent Kensington and Chelsea district costs as much as a two- bedroom apartment in Berlin's fashionable Prenzlauer Berg area.

Spilling Over

Potential ``spillover'' effects from a real-estate bust would go beyond household budgets and the banking system, say analysts at ABN Amro in London. Falling home values could undermine confidence in the pound and boost inflation, the analysts wrote in an April 4 report.

``Financial imbalances can and do also develop in a low- inflation environment,'' Borio said in a paper published in September. The BIS, formed in 1930, promotes cooperation among central banks and provides facilities for international financial operations.

``Low inflation, by obviating the need to tighten monetary policy, can also remove a key constraint on the development of the imbalances,'' Borio said. ``There is a risk of unwittingly accommodating their build-up.''

That danger calls for ``running a tighter policy regime at low levels of inflation than a strict price rule might otherwise suggest,'' says Stephen Roach, chief economist at Morgan Stanley in New York. ``Central banks have ignored these risks over the last decade at great peril.''

Trichet's Approach

Trichet, 64, says that monitoring a broader range of measures can provide clues about imminent asset bubbles and give policy makers opportunity to ``lean'' against them. Officials at the Bank of England and the Fed counter that attempting to steer asset prices carries the risk of causing a crash.

``We are targeting inflation, not house prices, and we are concerned about the outlook for the economy as a whole,'' King told lawmakers in November.

There's wisdom in keeping the focus on inflation, says Christopher Allsopp, who served on the Bank of England's Monetary Policy Committee between 2000 and 2003.

``A lot of the worry about these things comes from the expectation that the Bank of England is God,'' says Allsopp, who now teaches economics at Oxford University. ``It's not. There's a real danger we're overloading central banks with things to do.''

King argues that asset values are inflated by many factors outside the bank's control, and it's better off focusing on a single gauge of consumer prices.

World Capital Markets

``What determines asset prices in the U.K. is very much a function of what's going on in the world capital markets,'' he told a parliamentary committee on April 24. ``The impact of higher asset prices can't just be linked solely and exclusively to U.K. monetary policy and credit growth.'' Immigration and a property shortage caused by planning restrictions are also driving U.K. real-estate prices higher, policy makers say.

Still, King acknowledges that ignoring money supply and credit growth may lead policy makers into ``tricky territory.''

In 2005, he became the first Bank of England governor to be outvoted by his committee when it decided to ignore the fastest money-supply expansion in eight years and cut rates to shore up economic growth.

``In retrospect, it was a mistake,'' says Thomas Mayer, chief European economist at Deutsche Bank AG in London. The move reignited the housing market, sending the price of an average London home surging by a quarter. House-price inflation stood at 9.1 percent at the end of 2006, the London-based National Institute of Economic and Social Research said in a report today.

Memories of Major

Such rapid appreciation evokes memories of the U.K.'s last house-price boom and bust. In the late 1980s, Prime Minister Margaret Thatcher's Conservative government helped stoke a surge in real-estate prices by slashing taxes and interest rates. By the 1990s, prices were in freefall after her successor, John Major, raised borrowing costs as high as 15 percent in a failed bid to keep the pound in the Exchange Rate Mechanism, a forerunner of today's European monetary union. As a result, the economy spent the early 1990s in or near recession.

Such booms and busts show policy making isn't just about analyzing fluctuations in demand, supply and inflation, Mayer says. ``I don't think it's working fine,'' he says of inflation targeting. ``You can't pretend that financial markets don't exist.''

To contact the reporter on this story: John Fraher in London at jfraher@bloomberg.net

Last Updated: April 29, 2007 22:42 EDT