By Carla Mozee, MarketWatch

LONDON (MarketWatch)-- U.K. stocks dropped sharply Friday, with real estate shares under pressure as investors assessed the likelihood of regulatory and monetary policy changes, including the arrival of an interest-rate increase sooner than had been anticipated.

British retail issues also fell, moving alongside other European equity markets as an escalation of violence in Iraq sent energy prices soaring.

The U.K.'s FTSE 100 index stumbled 1% to 6,777.85, its worst loss since April 11, according to FactSet data. The index fell 1.2% for the week, its first loss in three weeks.

British economic growth "has been much stronger, and unemployment has fallen much faster than either we or anyone else expected," a year ago, Bank of England Governor Mark Carney told business leaders at the annual Mansion House dinner in London late Thursday.

With that, there's been "already great speculation about the exact timing of the first [interest] rate hike, and this decision is becoming more balanced. It could happen sooner than markets currently expect," Carney said.

The benchmark rate is at a record low 0.5% and has been at that level since March 2009.

Carney said the rate rises "will be gradual, and data-dependent, but the qualifications won't matter to a market which prices a slow pace of rises, starting next year," said Kit Juckes, a foreign-exchange strategist at Société Générale, in a note Friday. The pound jumped in anticipation of a rate hike, closing in on a five-year high against the dollar.

Also speaking at Mansion House, Britain's finance minister George Osborne said he would give the central bank greater power to curb mortgage lending, in a bid to reduce any risks from the housing market to financial stability.

Housing stocks swam in the red, with residential property firm Persimmon PLC losing 7%, Barratt Developments PLC lower by 6.3% and real-estate investment trust Hammerson PLC off 3.4%.

Financials struggled as Lloyds Banking Group shed 2.4% and HSBC Holdings PLC (HSBC) fell 0.7%

Markets had been pricing in a rate hike to take place around the second quarter of 2015, but two-year swap rates have risen more than 15 basis points on Thursday's level, said Berenberg in a note Friday.

The pound (GBPUSD) bought $1.6962 compared with $1.6906 late Thursday. On Wednesday, it fetched about $1.6791.

The pound/dollar pair is retesting the $1.70 level, "and my belief that this is pretty much the top will be sorely tested," said Juckes. "In the short run, U.K. data is better and Carney sounds more willing to raise rates early than [Federal Reserve Chairman Janet] Yellen. There isn't much point fighting the move."

Retail stocks were crunched on Friday as a leap in oil prices raised concerns about consumer spending and costs for businesses. Brent crude during the day traded above $114 a barrel, at around nine-month highs, after Kurdish forces took control of a provincial capital in Iraq's oil-rich north and the Iraqi government launched airstrikes on insurgent positions in Mosul. Read: 5 things you need to know about Iraq right now.

Shares of supermarkets, apparel and consumer-discretionary retailers were yanked lower. Next PLC fell 2.7%, Marks & Spencer PLC was dragged down 2.5%, J Sainsbury PLC lost 0.9% and Burberry Group PLC traded 0.8% lower.

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