LONDON (Reuters) - New British home loan approvals nosedived at their sharpest annual pace in at least a decade to hit a record low in May, figures showed on Tuesday, raising fears the housing slowdown is about to escalate into a crash.

The credit crunch has forced banks to toughen up lending terms, making it harder for Britons to get affordable mortgages and house prices have already started to fall at monthly rates not seen since the slump of the early 1990s.

Economists worry that a housing market meltdown will drag the economy into recession at a time when the cost of living is rising fast as food and fuel prices soar on global markets.

The British Bankers' Association said mortgage approvals for house purchase - an indicator of future house prices - fell to 27,968 in May from 34,752 in April. That was 56 percent down on a year ago - the biggest drop since the series began in 1997.

"A very worrying picture of how the credit crunch is unfolding. A US-style housing slump looks increasingly likely," said Michael Hume, an economist at Lehman Brothers investment bank.

"The drop in mortgage approvals and lending points to a housing market that is rapidly grinding to halt under the pressure of higher mortgage interest rates, tighter bank lending standards, and declining confidence."

One Bank of England (BoE) policymaker - arch dove David Blanchflower - has suggested house prices could fall by about a third unless the central bank acts now.

And signs of worsening conditions will do little to help struggling Prime Minister Gordon Brown who has lost the public's confidence on the economy in the wake of the collapse of credit crunch victim and mortgage lender Northern Rock.

Two thirds of Britons own their homes, putting millions at risk of negative equity - when the house value falls below its mortgage - if house prices crumble. However, that may be a way off yet, given that prices trebled over the last decade.

While soaring commodity prices across the globe have forced inflation to the top of the political agenda and convinced financial markets that interest rates are heading higher, most economists expect rates will eventually have to fall.

Even hawkish BoE policymaker Andrew Sentance said this week he expected slowing growth to help cool price pressures, suggesting the central bank is in no hurry to raise rates.

But lower borrowing costs are unlikely to come in time to help anyone in Britain looking to buy a home.

Despite three cuts in official interest rates to five percent since December, banks have actually been raising rates on their mortgage deals because the credit crunch has made it harder for them to get hold of cheap funding on financial markets.

The amounts that banks have already lent to customers is also starting to come off the boil, with mortgage lending rising by four billion in May, down from a 5.2 billion pound increase in April and the weakest rise since October 2007.

"With no evidence that the mortgage credit squeeze is easing, affordability still poor, unemployment now rising and falling house prices likely to dent buyer confidence further, it is hard to avoid the conclusion that the housing market correction will be deep and prolonged," said Ed Stansfield, a property economist at consultancy Capital Economics.