House prices in the United Kingdom dropped 0.9 percent in August from July -- the largest decline in six months – as a greater supply of properties provided purchasers with more bargaining power, according to the Nationwide Building Society.

From the year-ago period, prices have increased 3.9 percent, which is a weaker pace than the 6.6 percent recorded in July, 8.7 percent in June and a peak of 10.5 percent in April.

In July 2010, prices had dropped 0.5 percent, while they were flat in June.

“As more sellers have returned to the market, buyers have a greater selection of properties to choose from and more bargaining power with which to bid down asking prices,” said Nationwide's economist Martin Gahbauer in a statement.

“Given that the price increases of the last year had gotten ahead of the recovery in the wider economy, the current correction is not an unhealthy development.”

More properties have been coming on to the market for some time now, thereby moving the supply/demand balance more in favor of buyers, explained Howard Archer, chief UK/European economist at IHS Global Insight in London explained that the supply/demand shift in favor of buyers is particularly relevant “as a shortage of properties in 2009 and early-2010 was a key factor in the recovery in house prices from their early-2009 lows.”

The drop in housing prices in August comes on the heels of a report by the Bank of England last week that Britain's mortgage activity remained muted in July.

The U.K. housing-market recovery is waning in the face of the government's massive budget squeeze that will likely hurt consumer confidence.

Nationwide also reported that the percentage of borrowers on fixed interest-rate mortgages declined to 36 percent in the first quarter of 2010 from 48 percent at the end of 2008 because of “attractive” variable rates. Although this will leave borrowers exposed to higher interest rates, Nationwide said it expects the Bank of England to keep its benchmark interest rate on hold until “well into 2011.”

Gahbauer added, however, that the decline in house prices is “likely to remain relatively modest” as there is “little evidence” of people being forced to put their homes up for sale.

Nonetheless, the recent overall tone of housing market data and surveys has been consistently downbeat, said Archer.

“We currently expect house prices to fall by 3 percent over the second half of the year, but there is a now a very real likelihood that the drop will be nearer 5 percent,” he stated.

Archer adds that housing market activity is currently low because the economic fundamentals are far from ideal – notably high unemployment and muted wage growth and a major fiscal squeeze is getting underway.

“On top of this, credit conditions remain tight with mortgages still hard to get for many people,” he noted.

“Furthermore, household confidence is relatively weak with concerns over both personal financial situations and the economic outlook fueled by the extra austerity measures that were announced in June's emergency budget. There are also concerns that the Bank of England will raise interest rates before the end of the year due to sticky, above-target inflation. The more worried that consumers are, the less likely they will want to commit to buying a house.”

Archer added that it is hard at this stage to be optimistic about house prices in 2011 as the fiscal squeeze will increasingly kick in, which will hit people's pockets and lead to serious job losses in the public sector.

“Consequently, a further drop around 5 percent in house prices looks highly possible in 2011, and the drop could well be steeper still,” he said.

“Much will depend on mortgage availability and the amount of houses coming on to the market as well as how well the economy holds up. Therefore, we suspect that house prices will be at least 10 percent lower by end-2011 compared to their mid-2010 levels.”

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