LONDON (REUTERS) - London's Heathrow Airport must cut the fees it charges airlines to reduce the substantial market power it has built up, the industry's regulator said on on Tuesday, in a move which could lead to lower air fares for travellers.

The UK's Civil Aviation Authority (CAA) said Heathrow, the world's third busiest airport in terms of passenger numbers, should cut take-off and landing charges by inflation minus 1.3 per cent between 2014 and 2019.

Controlled by Spanish infrastructure group Ferrovial , Heathrow's 2012 profits rose 12 per cent to 1.3 billion pounds (S$2.5 billion) in February largely driven by an increase in the fees it charges airlines, its largest source of revenue.

Earlier this year Heathrow, which has raised airport tariffs by an average of 12.5 per cent since April 2011, said it should be allowed to increase charges by 5.9 per cent each year in real terms between 2014 and 2019.

This would see the fees, which are passed on to passengers by airlines, rising to to 27.30 pounds per person from the current 19.33 pounds.

However, the CAA said on Tuesday it had "found clear evidence of substantial market power" at Heathrow and "after a decade when prices have risen ... is now looking to encourage further investment whilst improving value for passengers in other ways."

Heathrow, which has invested 11 billion pounds over the last ten years in new terminals and facilities, argues that it needs to raise charges to help it better compete with rival hubs such as Amsterdam, Paris, Frankfurt and Dubai.

Mr Willie Walsh, the chief executive of British Airways parent IAG, said the proposals did not go far enough however.

"Heathrow airport is over-priced, over-rewarded and inefficient and these proposals, which will result in an increase in prices, fail to address this situation," the head of the largest airline at Heathrow said in a statement.

The CAA said charges at London's second-largest airport, GIP-owned Gatwick, should rise by inflation plus 1 per cent for the five years from April 2014, despite Gatwick's calls for the removal of what it calls the "regulatory barriers to growth".

At London's Stansted airport the CAA said it would move away from setting a five year fixed price cap, and instead introduce a price monitoring regime.

Stansted, which is predominantly a low-cost leisure and holiday airport, is based 50 km northeast of central London, and was bought by Manchester Airports Group last month.

The CAA will make a final decision on whether to apply its recommendations in January 2014.