LONDON (Reuters) - The Bank of England held interest rates at five percent for the second month running yesterday despite growing evidence that the economy is braking sharply and signs the housing market could be in for a hard landing.

Inflation is running a full percentage point above the central bank's target and is expected to go higher, limiting the bank's scope to cut rates to boost the economy. Money markets had priced in almost no chance of a reduction at this month's Monetary Policy Committee meeting.

But analysts say the BoE will soon have to cut rates again — borrowing costs have already come down three times since December — to bolster an economy battered by a global credit crunch and soaring food and energy prices.

"The economy is clearly slowing and the housing market has deteriorated sharply, so the MPC will need to cut rates later this year to head off the risk of a recession," said John Hawksworth, head of macroeconomics at PricewaterhouseCoopers.

Figures out while policymakers were still meeting showed British house prices plunged 2.4 percent last month. More than £12,000 has been wiped off the value of the average home over the last year.

With two-thirds of British households owning their homes, consumer confidence has crumbled and voters have lost faith with Prime Minister Gordon Brown's Labour government.

Political pressure for a rate cut to ease the troubled housing market is growing. Lawmakers pressed Finance Minister Alistair Darling in Parliament just before the BoE decision to get the central bank to worry less about inflation and more about growth.

He replied that monetary policy is a matter for the independent central bank. BoE policymakers are braced for more criticism as the economy faces what Governor Mervyn King has called the most challenging time in more than a decade.

The main problem is that the BoE's mandate is to keep inflation at two percent. It is now at three percent and set to rise because oil and food prices keep going up and the pound falls.

Policymakers fear reducing interest rates when inflation is so far above the two percent target would risk the BoE's credibility to an extent that higher prices would become entrenched in people's minds.

Central bankers around the world face the same balancing act. In Frankfurt, the European Central Bank also kept rates unchanged yesterday.

The US Federal Reserve is also getting more worried about inflation and markets are betting interest rates could rise there before the end of the year despite no sign the housing crash is about to end.

Fears are growing Britain's housing market could also be headed for a full-blown crash as cash-strapped lenders make it harder for prospective buyers to raise mortgages.

Many economists are forecasting double-digit house price falls this year and next, raising the prospect of millions once again in negative equity — when mortgage debt exceeds the value of no chance of a reduction at this month's Monetary Policy Committee meeting.