Oct. 26 (Bloomberg) -- U.K. house prices are likely to reverse recent gains as the economy struggles to recover from recession, former Bank of England policy maker David Blanchflower said.

“The reality is that the real economy is on its back,” Blanchflower said in an interview with Bloomberg Television in London today. “If house prices continue to fall, as I believe they will, we’re going to see around 3 million people in negative equity,” where mortgage debts exceed the value of the property.

U.K. gross domestic product unexpectedly dropped in the third quarter, extending the recession to the longest since records began in 1955. Recent house price gains and a recovery in stock markets may be a bubble, Blanchflower said.

“We need to somehow or other get that economy moving again,” said Blanchflower, a Dartmouth College professor who left the Monetary Policy Committee in May. “The worry going forward is what are you going to do about all these folks who are in negative equity?”

Evidence of a revival in the stock and housing markets are not based on a real pickup in the economy, he said.

“This stock market looks awfully like a bubble to me again,” he said. “Where’s the evidence in real economy, where are the firms that are hiring folk?”

The central bank, which sets interest rates to keep the year-on-year increase in consumer prices to 2 percent, should have included house prices when targeting inflation, Blanchflower said.

“If we’d had the housing market in the index the Bank of England targeted, things would actually have been better,” he said.

If house prices were included in the central bank’s inflation forecasts, policy makers would have already had to increase the size of their asset-purchase plan further, he said.

To contact the reporters on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Mark Barton in London at barton1@bloomberg.net.

Last Updated: October 26, 2009 06:41 EDT