A survey released last week by Halifax, UK’s leading mortgage lender showed a 2.5 per cent monthly fall in house prices.This is being seen as a signal that the impact of the credit crunch was now poised to move from the financial sector to home owners in middle Britain.

The stunningly large drop in house prices in March is the second largest in the history of the Halifax index, beaten only by the fall recorded in 1992 when the housing market was in the grips of a full-blown crash. There is a clear risk that this housing market correction will be sharper and deeper than currently expected.

March’s fall is certainly large, but not so surprising given the sharp tightening in mortgage lending standards seen to date. Going forward, the situation is unlikely to improve.

In the view of Seema Shah, property economist at the Capital Economics Limited (CEL), a London-based research organisation, the economy is in for a rough ride with growth slowing and unemployment rising, and conditions for the housing market will be further exacerbated as lenders continue to cut back on lending.

CEL is forecasting house prices to fall by five per cent this year, and eight per cent next, “there is a clear risk that some of next year’s falls are brought forward. ”To some who have in the immediate past seen the house prices shoot beyond what they could afford, falling prices appear to be good news.

But if the predictions of a recession come true, then in a stagnating economy jobs and wages will become dearer and make it impossible for intending home buyers to mobilise the resources to afford a house even if the prices fall. Besides, in the changed credit situation, the banks would be too stingy with their mortgage offers.

Meanwhile, sterling was the biggest casualty on the currency markets after Halifax said British house prices had fallen in March. One consequence of the credit crunch has been that UK banks have found it difficult to raise funds for mortgages, and have cut back sharply on their lending to home owners

The IMF says that UK house prices might be over-valued by up to 30 per cent, based on fundamentals and historic values. The Bank of England’s Monetary Policy Committee was widely expected late last week to cut interest rates from the current level of 5.25 per cent. But despite earlier rate cuts, mortgage rates have not fallen as banks have become more concerned about risky loans and falling house prices.

The Alistair Darling, the Chancellor said, he was sympathetic to the plight of home owners. “We need to do everything we possibly can to help people through what is undoubtedly a difficult period. “That means making sure we support the housing market but also making sure we support the wider economy, keeping people in work.”

Mr Darling announced that he was creating a new working group, chaired by former HBOS chief executive Sir James Crosby, to find ways to “re-open” the UK’s ailing mortgage market.

Housing market in Britain has been growing at a dizzying rate in the last ten years moderating for short periods in a few months in 2004 and 2005. Between the first quarter of 1997 and the first quarter of 2007, house prices rose by 214 per cent.

According to the Royal Institution of Chartered Surveyors, estate agents have been grappling with the worst housing market conditions—measured by the ratio of completed sales to unsold stock—since September 1996. During the steep rise in house prices the spin heard was that the days of boom and bust were over, now it is an unending boom.

But the bubble finally burst because low debt servicing costs a consequence of low interest rates and had made it possible for even low earners to buy houses even though prices were too high compared to average earnings. Meanwhile, the supply was not keeping up with the demand which made prices to keep soaring.

The weakening housing market has diverted attention from the crash which has already occurred in the commercial property market. But the commercial property downturn could hit the wider economy by denting construction investment, reducing firms’ collateral and – most worryingly – prolonging the credit crunch.

The UK’s commercial property stock was worth around £740 billion in 2006, a fraction of the £4,000 billion or so of residential property. Nonetheless, commercial property accounts for 11 per cent of total non-financial assets in the economy and some 30 per cent of non-financial business assets.

What’s more, commercial property prices have already fallen sharply and it is thought that the eventual fall will be about 30 per cent. When commercial property prices previously fell this sharply – in the mid-1970s and early-1990s - the economy fell into recession.

Immediately after the Halifax survey figures were out, Prime Minister Gordon Brown attempted to reassure home owners and urged them not to panic. He told the BBC: “We’ve seen house prices rise by about 180 per cent over the last 10 years and they have risen by about 18 per cent over the last three years, so a 2.5 per cent fall is something that is containable.” He also claimed that the number of UK homes being repossessed was “a fraction of what happened in the early 1990s”.

Meanwhile, the IMF’s World Economic Forecast, released mid-way through last week said that the UK economy will slow sharply to a growth rate of just 1.6 per cent in both 2008 and 2009.

The IMF said that the UK economy would be affected by a weakening housing market, the contraction of the financial sector, and the impact on UK exports of weaker growth in the US and Europe.

But the Chancellor Alistair Darling defended his economic forecast and held that there were grounds for optimism despite what he described as the “unprecedented shock to the economy.”

Mr Darling said that the UK still had a strong economy that according to him had proved remarkably resilient in the slowdown. He said the IMF had downgraded the UK by less than other major economies and added, he was sticking by his forecast made in last month’s Budget that the UK economy would grow by between 1.75 and 2.25 per cent in 2008 and by 2.25 to 2.75 per cent in 2009, substantially above IMF projections.

Any sharper slowdown in the UK economy would also widen the gap between income and expenditure which has already estimated to have expanded to £45 billion.