By David Milliken and Huw Jones

LONDON (Reuters) - The Bank of England took steps on Tuesday to ensure British banks keep lending as the financial consequences of the country's decision to leave the European Union began to materialize, especially in commercial real estate.

Sterling hit a fresh 31-year low against the dollar after three big investment firms halted trading in real estate funds, reflecting fears of a Brexit hit to the property market.

There were other signs of how the fallout from the referendum was hitting the economy. Business confidence plunged after the vote, a survey showed, and retailer John Lewis said its sales grew more slowly last week.

The BoE, which is trying to cushion the economy from the June 23 referendum result, said it would lower the amount of capital banks must hold in reserve, freeing up an extra 150 billion pounds ($196 billion) for lending.

Governor Mark Carney recalled the central bank's warnings in March that the referendum was the biggest near-term domestic risk to financial stability. "Some of those risks have begun to crystallize," he said.

Separately, finance minister George Osborne met the heads of top banks and they issued a joint statement afterwards to say the lenders would free up more capital for lending.

The BoE's move represented a reversal of a decision it took earlier this year, when it started tightening the screws on lenders because the economy had appeared set for more growth.

"It means that three quarters of UK banks, accounting for 90 percent of the stock of UK lending, will immediately have greater flexibility to supply credit to UK households and firms," Carney said.

It remains to be seen if consumers and businesses will want to borrow while Britain's economic prospects remain uncertain.

Prime Minister David Cameron has said he will resign but his successor is not expected to take office until September, deepening the uncertainty. Cameron has left it up to the next government to decide how Britain might rework its ties with the EU, something which could take years to negotiate.

Sterling resumed its fall, sinking as much as 1.7 percent to its lowest level against the dollar since September 1985. It was down 1.4 percent against the euro. Yields on 10, 20 and 30-year British government bonds hit new record lows as investors around the world sought the safety of sovereign debt.

PROPERTY WORRIES

The pound slid after the fund arm of insurer Aviva <AV.L> suspended its 1.8 billion-pound UK Property Trust, following a similar move on Monday by Standard Life <SL.L>. Later M&G, the fund management arm of insurer Prudential <PRU.L> also temporarily closed its fund.

The BoE said foreign flows of capital into commercial real estate dropped 50 percent in the first three months of 2016 and transactions fell further in the second quarter, an extreme example of concern among investors about the referendum.

Although the closure of the funds brought back memories of the aftermath of the financial crisis in 2008-2009, Eduardo Gorab, a property economist at consultancy Capital Economics, said the limits on outflows could help prevent a collapse in values.

On the stock market, housebuilding firms were trading sharply lower, with shares in Berkeley Group <BKGH.L>, Barratt Development <BDEV.L>, Taylor Wimpey <TW.L> and Persimmon <PSN.L> all down more than 6 percent.

The BoE said it was closely monitoring investors' willingness to fund Britain's large current account deficit, high levels of household debt and the subdued global economy.

"The current outlook for UK financial stability is challenging," it said.

But there were also signs of calm. A BoE auction to provide banks with liquidity and a sale of British government bonds went smoothly. The fall in sterling could encourage foreign investors to buy gilts, a senior official at the UK Debt Management Office told Reuters.

Carney said the fall in sterling should help to ease the balance of payments shortfall although the pace of investment would also be important.

More responsibility has fallen on Carney and the BoE to steer Britain through its political crisis because of uncertainty over Osborne's future as finance minister.

Carney said last week that he believed the BoE would ease monetary policy soon. A Reuters poll showed economists mostly expect the Bank will not cut interest rates when it meets next week and wait until August instead.

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

Also on Tuesday, the BoE gave insurers more time to adjust to new EU capital rules to avoid pressure on them to dump corporate bonds. The central bank said it would keep a close eye on the buy-to-let mortgage sector, in case landlords sell as property prices fall, and on the rising numbers of indebted households.

(Writing by William Schomberg and David Millken; additional reporting by Andy Bruce, Jemima Kelly, James Davey, Dhara Ranasinghe and Carolyn Cohn; editing by Anna Willard and David Stamp)