British house prices are 30 per cent too high and could crash as they did in the early 1990s, although moderate price declines look more likely, a respected economic forecasting group has warned.
The National Institute for Economic and Social Research (NIESR) urged the Bank of England to raise interest rates by an aggressive half a percentage point next week to cool the housing market, warning that a price crash would dent economic growth in future years.
The think-tank also said that fiscal policy was now unhelpfully expansionary. "House prices are currently around 30 per cent above their equilibrium level \ it is possible that they might fall rapidly, as they did after the last two house price bubbles, rather than moderately as is our baseline forecast," the NIESR said.
The governor of the Bank of England, Mr Mervyn King, was surprisingly candid last month, warning Britons used to cheap money and soaring property values that it would be dangerous to assume house prices and interest rates were a one-way bet.
And Bank of England chief economist, Mr Charles Bean, warned on Wednesday that there could be a sharp correction, although he added that a soft landing in the housing market - something the Bank of England has been forecasting for years - was still "entirely possible."
The Bank of England has raised interest rates four times since November, with back-to-back quarter-point hikes in May and June, partly to cool rampant house price inflation and curtail consumer debt.
Most economists expect another quarter-point hike to 4.75 per cent next week, but the NIESR report said more drastic action from the Monetary Policy Committee was required.
The NIESR said it assumed that the Bank of England would welcome a correction in house prices and would not cut rates to halt one, even though a house price crash would likely shave a quarter percentage point off annual economic growth over the next four years.
The last two house price booms in Britain were followed by crashes, although many analysts argue that circumstances have changed.
The economy is near full employment and low interest rates have made mortgages much more affordable given the level of take-home pay.
