House price rises of ?100 a day expected to push up interest rates

Interest rates seem certain to rise next week after the Nationwide building society yesterday reported another surge in house prices. But an economic thinktank issued a warning that the boom could soon turn to bust with prices plunging by up to 40%.

The building society said prices jumped a hefty 2.1% in April to give an annual rise of 18.9%, the strongest since June last year and a clear sign that homeowners have not been cowed by two interest rate rises since November.

Coming on the top of data showing mortgage lending running at record levels in March, economists said the Bank of England was almost certain to raise the cost of borrowing again, to 4.25%, at next week's rate meeting.

A poll from Reuters yesterday showed that 45 of 46 City economists expect rates to rise next week, the third increase since November. Although members of the Bank of England's nine-strong monetary policy committee stress they are targeting inflation - which remains at just 1.1% - they are getting twitchy about house prices, which have more than doubled in five years thanks to falling interest rates and rising employment.

The latest rises have taken the average house price in Britain to just over £145,000 and means prices are rising at more than £100 a day.

House price growth slowed through much of last year but has speeded up again this spring, taking most experts by surprise. The Nationwide's chief economist, Alex Bannister, has raised his forecast for this year to a rise of 15% from an original forecast of 9%.

With prices up 7% in the first four months, the pace of increase would slow in the second half because of slowing income growth and rising interest rates, which he sees up at 4.75% by year end. "How ever, the pace of price growth we are expecting this year is clearly unsustainable given that affordability has become so stretched," he said, adding the market could be in for a long period of stagnation rather than any collapse.

His optimism was not shared by the National Institute of Economic and Social Research, which thinks another 1990s-style house price slump is looming.

"My personal guess is that house prices may be 30-40% above where they should be. The chance of a slowdown in house prices is very high," said its senior research fellow Ray Barrell, adding that a house price slump would damage the economy.

Other experts such as economist Roger Bootle and fund manager Tony Dye are also predicting a house price slump in the order of 30%, but the two-thirds of Britons who own their homes must be hoping they are wrong. First-time buyers, however, would wel come a price crash. The number of first-time buyers entering the market is at a 20-year low. Mr Bannister said high prices meant young people could no longer afford a property and the market was being driven by homeowners trading between themselves.

He also said there was still a strong north-south divide with properties in the cheaper north rising fast but London and the south-east rising much more modestly.

Separate research from the Skipton building society predicted that high house prices would be one factor leading to a trebling of the number of three-generation households over the next 20 years.

High prices would deter children from leaving home while pension underfunding and the spiralling cost of residential care would mean some pensioners would have to move in with their children, it said.