UPDATE 1-Bank of England eases rules for banks to meet Brexit challenge

(Adds market reaction, background)

By David Milliken and Huw Jones

LONDON, July 5 (Reuters) - The Bank of England took steps onTuesday to ensure British banks keep lending and insurers do notdump corporate bonds in the "challenging" period that is likelyto follow the country's vote to leave the European Union.

The central bank said risks it had identified before thereferendum were starting to materialise, including lower demandfor commercial property. Late on Monday, insurer Standard Life said it had halted withdrawals from its main Britishreal estate fund.

The central bank also said it was closely monitoringinvestors' willingness to fund Britain's large current accountdeficit after the shock outcome of the vote, as well as highlevels of household debt and the subdued global economy.

"There is evidence that some risks have begun tocrystallise. The current outlook for UK financial stability ischallenging," the BoE said after its Financial Policy Committeeheld two meetings after the June 23 referendum.

Sterling dropped more than 10 percent against the dollar andbanks' share prices fell by a fifth after Britons unexpectedlyvoted on June 24 to leave the EU, prompting Prime Minister DavidCameron to say he would step down.

Sterling touched a new, 31-year low against the U.S. dollarearlier on Thursday, hurt by Standard Life's suspension oftrading in its British real estate fund.

Twenty and 30-year British government bond yields brieflytouched new record lows of 1.473 percent and 1.606 percent afterthe BoE's announcement.

Cameron's ruling Conservative Party is now selecting a newleader, who will decide how soon and on what terms Britain willleave the EU after more than 40 years of membership.

With uncertainty about the future of George Osborne asfinance minister, more responsibility has fallen on Bank ofEngland Governor Mark Carney and his fellow BoE policymakers tosteer Britain through its worst political crisis in decades.

Fresh signs of weakness in Britain's economy appeared onTuesday.

Confidence among businesses fell sharply in the data afterthe vote to leave the EU, a survey showed, and retailer JohnLewis said its sales grew more slowly last week.

Britain's dominant services industry also grew at itsslowest pace in three years in June, according to a surveyconducted mostly before the referendum.

BOE EASES CAPITAL REQUIREMENT

As part of its announcement on Tuesday, the BoE's FinancialPolicy Committee said it would reverse a decision it took inMarch to increase the amount of capital banks must hold againstcyclical upturns in the credit cycle.

Holding the so-called counter-cyclical capital buffer (CCB)at zero until at least June 2017 would reduce banks' capitalrequirements by 5.7 billion pounds, potentially freeing up anextra 150 billion pounds for lending, the BoE said.

Finance minister Osborne told parliament he planned to meetthe chief executives of Britain's biggest banks on Tuesday todiscuss future action.

"The FPC stands ready to take actions that will ensure thatcapital and liquidity buffers can be drawn on as needed, tosupport the supply of credit and in support of marketfunctioning," the BoE said.

It has intensively monitored markets since June 24, rampingup checks it made during the 2008 financial crisis.

After the initial market turmoil following the Brexit vote,British lenders showed only contained demand for central fundsat a six-month liquidity auction last week, including at anauction held on Tuesday.

The BoE has said the normal monthly auctions would continueweekly as a precaution.

"These measures are really about Carney aligning the Bank ofEngland's guns in case the UK economy enters a downturn,"Aberdeen Asset Management Investment Manager James Athey said.

"Markets are going to be reassured by his proactivity. He'snot waiting for anything bad to happen but rather acting in caseit does."

Carney has said he believes the central bank would need tocut rates and possibly provide other stimulus over the summer tocushion the shock of voting to leave the EU.

The BoE on Tuesday gave insurers more time to adjust to newEU capital rules to avoid pressuring them to dump corporatebonds and avoid high capital charges as interest rates plunge.

Before the referendum, consumer borrowing was rising at itsfastest rate in a decade while mortgage lending had easedslightly as higher taxes on landlords and second-home buyerstook effect in April.

The BoE said it would keep a close eye on the buy-to-letmortgage sector, in case landlords sell up as property pricesfall, as well as on the rising numbers of vulnerable indebtedhouseholds.

It expressed concern about a fall in investor demand forBritish assets - which could make it harder for the country tofinance its large current account deficit - as well as troublein commercial real estate making it harder for businesses to usetheir property as collateral to obtain loans. (Writing by David Millken and William Schomberg; additionalreporting by Andy Bruce, Jemima Kelly and James Davey; editingby Michael Holden)