Homeowners told house prices could fall by 30%

Britain's homeowners were warned by a senior member of the Bank of England's interest-rate committee yesterday to brace themselves for the "significant probability" that house prices will fall by up to 30%.

In the Bank's second blunt assessment of the market in the past three months, Steve Nickell said the boom in prices had left them far above their long-term average level and vulnerable to a sharp downward move.

Mr Nickell, one of the nine members of the Bank's monetary policy committee, said: "It is obvious that there is a significant probability that house prices will fall at some stage."

The UK's biggest mortgage lender, the Halifax, reported the first fall in house prices last month in almost two years, but Mr Nickell said there was the risk of a much bigger correction.

Based on the long-term relationship between house prices and average earnings, of about 3.5 times, he said house prices would have to fall around 30% to re-establish the average of the last 20 years.

Mr Nickell's warning came after the Bank's governor, Mervyn King, said in June that house prices had risen so far in recent years that there was a growing danger that they could fall. Mr King's comments sent a shockwave through the housing market as buyers took fright.

The Bank has also been raising interest rates since last November, at least in part to try to deflate the housing bubble gently. It has put them up from 3.5% to 4.75% but the City thinks it may not raise them much further, if at all, especially if the housing market goes into reverse.

That belief was reinforced yesterday when the Office for National Statistics reported that the annual inflation rate slipped from 1.4% to 1.3% last month, well below the Bank's 2% target.

A slower than usual recovery in clothing and footwear prices this year compared to last was the main reason for the fall.

With an election looming, the government has been dismissing the idea of a crash in house prices that might overshadow an election campaign and Mr Nickell said there was a possibility that there would be a so-called soft landing for the property market.

Housing market experts are divided between those who argue that high employment and low interest rates mean there is no reason for house prices to fall and pessimists who say house prices, which have more than doubled in the past seven years, are a bubble about to burst.

There was a chance, Mr Nickell said in a speech in London, that wages would grow more rapidly than house prices over the next few years, thereby bringing the ratio of prices to earnings back to their long-term average without a crash.

Mr Nickell added that it was very uncertain as to how quickly the house price to average earnings ratio would return to its equilibrium level and as to what impact a fall in house prices would have on consumer spending.

Mr Nickell rejected the commonly held idea that the country has been living beyond its means in a consumption binge fuelled by debt.

"This statement is more or less completely incorrect. The average quarterly growth rate of real household consumption since 2000 has been around 0.7%, almost exactly the same as the average ... in the UK since 1975. There is no consumption boom."

He added that debt levels had largely risen along with house prices and had had little knock-on effect on spending.

Housebuilder Redrow said yesterday the market was "normalising" but still fairly buoyant. Paul Pedley, Redrow's chief executive, said it had seen prices rising by 8% to 9% over the last 12 months. "We now expect them to average around 3% to 4% over the next year."