By Matt Falloon

LONDON (Reuters) - House prices fell in March at their sharpest pace since the recession of the early 1990s, the country's largest mortgage lender says, raising expectations that interest rates will be cut this week.

The surprisingly severe drop reinforced opinions that the housing market faces a bleak year as mortgage lenders grow more cautious and the credit crunch feeds through to households.

It is also another blow for Prime Minister Gordon Brown before regional and London mayoral elections as his reputation as a safe pair of hands on the economy fades.

House prices fell 2.5 percent during last month, the Halifax said, more than six times as much as analysts had forecast and the largest monthly decline since September 1992.

The annual three-month rate of house price inflation stood at 1.1 percent. Six months ago, that rate was in double figures.

"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," said Seema Shah, a property economist at researchers Capital Economics.

"There is a clear risk that this housing market correction will be sharper and deeper than we currently expect."

The pound fell and interest rate futures rose as the figures reinforced expectations that the Bank of England will cut interest rates by 25 basis points to 5.0 percent on Thursday to shore up the economy despite simmering inflationary pressures.