LONDON (Reuters) - British house prices fell in November at their steepest rate for 12 years and home loan approvals dropped to their lowest in nearly three years, boosting bets the central bank may cut interest rates next week.

The data released yesterday were a further sign Britain's once red-hot housing market is cooling. Sterling fell against the dollar and euro on the view that the chances of a cut in rates from 5.75 percent next month are strengthening.

Bank of England Governor Mervyn King said the outlook for both inflation and growth is worse than it was, but he and other members of the Monetary Policy Committee gave little indication they will cut borrowing costs next week.

"December's interest rate decision is shaping up to be one of the closest for some time," said Paul Dales, an economist at Capital Economics.

King told a parliamentary committee yesterday the economy was expected to slow in the coming year but inflation was also expected to rise in the short term before settling back at the two percent target in two years.

Concern over price pressures — with oil prices near $100 a barrel — could stay the central bank's hand for the time being. It's remit is to control inflation not growth.

Prices on the high street are soaring at their fastest rate in almost a decade, according to a report from the Confederation of British Industry which also showed retail sales growth picking up as the run-in to Christmas begins in earnest.

"We suspect that inflation worries mean that the BoE will remain cautious until broader signs of economic weakness are visible," said James Knightley, an economist at ING.

After years of double-digit growth Britain's housing market is expected to slow sharply over the next few months as lending conditions tighten in a global credit crunch and first-time buyers find it harder to make any purchase.

The Nationwide building society said the cost of an average home in Britain fell 0.8 percent in November — the first decline since February 2006 and the biggest drop since June 1995 — after a 1.1 percent rise in the previous month.

The Bank of England said approvals for new home loans in October, seen as a forward-looking indicator of the health of the housing market, fell to 88,000 from 100,000 a month earlier, the lowest since February 2005.

Mortgage lending also slowed more than expected to record its lowest increase since July 2005.

Clear signs of a housing market slowdown have put the Bank of England in a tough position and added to the woes of Prime Minister Gordon Brown who has taken a hit in the opinion polls after a series of scandals.

Brown is hoping the economy will bounce back before he has to call a national election, but the Scot may not be able to rely on the central bank coming to the rescue by slashing interest rates as the US Federal Reserve has done.

"It will be a delicate balancing act," the Bank of England's most doveish policymaker David Blanchflower told the Birmingham Post newspaper, saying rates should "come down now so we get ahead of the curve".

For now, Blanchflower is firmly in the minority with most central bank rate-setters showing little appetite to take pre-emptive action and preferring a wait-and-see approach.

King said the central bank was focused on keeping inflation at its 2.0 percent target and the Bank of England's chief economist, Charles Bean, said the expected slowdown was "relatively mild".