"We expect further deterioration in house prices to feed through to lower land values," the broker said as it downgraded Redrow (LSE:RDW) and Persimmon to sell from neutral.

Data down

House prices have fallen amid a tougher environment for the consumer and continued difficulties in the mortgage market as banks continue to deal with the fall-out from the credit market crisis that started last summer.

The latest data on the housing market came out Tuesday from the Royal Institution of Chartered Surveyors. Although the surveying body reported sentiment in the housing market across England and Wales rebounded slightly in May after 10 months of declines, they noted that the market remains under a lot of pressure.

"Further sizeable declines in house prices seem likely," said Citigroup economist Michael Saunders in a note released after the data.

Saunders also referred to Monday's shock wholesale inflation figures which led to a spike in two-year government note yields and a sharp sell-off in the front end of the sterling interest rate market.

"The recent sharp rise in 2-year swap rates is likely to feed through to further rises in fixed mortgage rates in coming weeks that - along with the trend of rising unemployment that is now emerging -- will deal new blows to the housing market," said Saunders.

And central bank rhetoric over the last week highlighting a tough stance on inflation has spooked markets hoping for rate cuts to shore up economic growth, although interest rates are much lower than they were in 1990, when they hit 14% .

That slowing economic growth is feeding through into the labor market showed up in figures from the Office of National Statistics out Wednesday which revealed that unemployment rose for the fourth consecutive month in April, with claimant count up 9,000 to 819,300.

"This increase was broadly in line with expectations and confirms that the labor market is easing as the effects of the credit crunch impact the real economy," said John Ward, managing economist at the Center for Economics and Business Research.

Merrill Lynch said that short to medium term trends on U.K. unemployment will be critical in determining both the real and stock market performance of the housing sector of the next nine to twelve months.

"If we refer to the late 1980's housing market boom and early 1990's recession...most importantly it was the conjunction of rising unemployment coupled with higher interest rates that adversely impacted on both housing activity and house prices," the broker said.

    (END) Dow Jones Newswires   06-11-08 0944   Copyright (c) 2008 Dow Jones & Company, Inc.