The trick is telling them they're wrong without making it sound like you are calling them stupid.
My question in the 'serious misunderstanding' realm would be whether this is a problem that this individual student is having, or is it a common misunderstanding across the class? In the latter case, I turn the question back out to the class, eg, "Who thinks that's the right answer, who thinks it's Something Else?" And then we demonstrate the the individual student isn't alone in the Serious Misunderstanding, and provide a bit of personal buffer between the response and the correction.
I want students to come away with a self-description of "I have lots of ideas, and they need to be carefully checked because sometimes they're wrong," as opposed to the incredibly prevalent "I'm bad at math."
Your example sounds very reasonable to me, but do you think that this is ever taken too far?
Coming to the US as a student from Europe (not the UK), I noticed that some instructors (mostly TAs) took this effort to give a "positive" response to any answer in class to quite an extreme. I can think of many instances where a student's answer showed a very serious lack of understanding, and the instructor would say something like "okay, that would be one way to think about it, but how about... " without every correcting the student.
Two negative consequences I saw were 1) a lot of missed opportunities for correcting students' misunderstandings 2) students seemed overly sensitive to any kind criticism (I had a German friend who was a TA and had quite a bit of trouble with this)
Again, none of this is incompatible with your advice, I just wanted to take the opportunity to see if anyone has noticed this as a common problem.