* Carney says rates may rise earlier than markets expect
* Case for rate rise now "more balanced", hinges on data
* Sterling nears five-year high against dollar on comments
* Carney says rate increases would still be gradual
British government bond yields soared, construction stocks tumbled and interest rate futures priced in a first hike by December after Carney said rates could rise sooner than markets had thought - his most hawkish comment to date.
"There's already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced," Carney said in a speech late on Thursday alongside British finance minister George Osborne.
"It could happen sooner than markets currently expect."
Few economists had expected rates to increase until the second quarter of next year given the central bank's previous guidance that there was plenty of scope for Britain's economy to expand further without causing inflation.
A rise in BoE rates this year would be the first since 2007 and put it ahead of both the U.S. Federal Reserve and the European Central Bank. The Fed is still pumping extra stimulus into the U.S. economy while the ECB cut interest rates to record lows last week and said it may not have finished easing.
Carney said Britain's economy still had room to grow without pushing up inflation, but added that he saw 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.
"The change reflects the reality in the economy. It is flying now. Employment is rising at a record pace and we see no sign of economic growth slowing from its current pace," said Rob Wood, chief UK economist at German bank Berenberg.
An interest rate rise before a national election next May could hurt perceptions of the Conservative-led coalition government by raising mortgage costs and eating into disposable income, which the opposition Labour party says is being eroded by rising prices for everything from energy to transport.
"It is absolutely without question that those people who are right on the edge at the moment will, with a small increase in interest rates, be pushed over the edge," Conservative lawmaker Mark Garnier told Reuters.
FLYING TOO HIGH?
Although Britain's $2.5 trillion economy had won back the output lost in the convulsions of the 2008 crisis, Garner said it could be a hard sell to convince voters of the recovery if they felt they had less money in their pockets.
"We can't just go to people and say: 'Yes, it's costing you more, but overall the economy is bigger'. They'll just turn around and say 'Well, it's not bigger for me'," he said.
While Britain's economy is growing fast now, its recovery began much later than in the United States or Germany, and wages have fallen significantly in real terms since the financial crisis.
The pound hit a 5-1/2 year high against a trade-weighted basket of currencies and was just a fraction below an almost five-year high against the dollar.
Short sterling rate futures fell <0#FSS:>, pricing in the first hike by December. The interbank interest rate curve (SONIA) also pointed to a rate rise by the end of the year, compared with the first quarter of 2015 on Thursday.
Carney said the central bank would weigh carefully the merits of tackling housing market risks, including an undesirable loosening in mortgage underwriting standards, when its Financial Policy Committee meets later this month.
House prices in London have soared in the past year and though rises outside the capital have been more modest, Carney cautioned that average household debt was 140 percent of disposable income - higher than in most other countries.
Osborne said he would grant the BoE new powers to impose maximum loan-to-value and loan-to-income ratios on mortgage lending, a step which Carney welcomed.
RATE RISE NEARING?
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 tightening, emphasising that Britain's economy was still a long way from full strength.
On Thursday, he 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 the timing of a rise would depend on incoming data, and the bank had no fixed plan on when to raise rates.