House price surge brings new warning of collapse

Fears of a slump in house prices grew yesterday as figures showed a surge last month in prices and mortgage debt, and a leading think-tank said there was an "evens" chance of a crash within two years.

The National Institute of Economic and Social Research said the longer the current boom continued, the worse would be the slump and its impact on the economy.

Its warning came just days after Gordon Brown, the Chancellor of the Exchequer, staked his reputation on a benign outcome for house prices, saying the market was on a sounder footing than before the crash of the early 1990s.

There was fresh evidence of a speculative boom from figures from Nationwide building society showing that prices jumped 2.1 per cent in April, equivalent to more than £100 a day.

The rise pushed annual house price inflation to 18.9 per cent, its highest level since June last year.

Meanwhile approvals for home purchases hit their highest level for nearly two years in March, the major banks said yesterday, pointing to a further surge in prices over the spring.

Ray Barrell, a senior research fellow at the NIESR, said: "There's a clear risk of a sharp fall in prices, especially in London where prices appear to be very high. I think the chances are evens at some point in the next two years."

He said house prices were as much as 40 per cent over-valued, adding that a crash could sending them tumbling by 20 per cent - equivalent to the gains of the past two years.

This would wipe as much as 1.25 per cent off economic growth - equivalent to £12.5bn in cash terms but not enough to deliver a recession. He said there was little the Bank of England or the Government could do to stop the crash.

He expected the Bank to raise interest rates only slightly because it targeted inflation rather than house prices, and said the Government's hands were tied by high levels of public borrowing.

"The only fiscal response would be to increase spending and cut taxes but that's the last thing we would expect," Mr Barrell said.

He said that if the Government had wanted to avert a price bubble it should have acted decisively to remove barriers to new housebuilding when it won power in 1997.

Nationwide building society said a drop in prices was "unlikely", saying the market was supported by falling interest rates, lack of supply and better rates of return than pensions or shares.

Alex Bannister, its chief economist, said the current rate of growth was unsustainable, but added: "Given the current economic climate it is not clear what the trigger for price falls would be."

At the weekend the Chancellor attempted to assuage fears of a slump, saying: "While house prices have certainly risen, it is also the case that people's debt servicing payments as a share of income are far below where they were 10 years ago."

In a sign that the housing market could become a political issue, Vince Cable, the Liberal Democrat treasury spokesman, urged the Government to take action against "irresponsible lending".

"Large numbers of people are gambling on the house price boom - a gamble they may regret if house prices start to fall or interest rates rise," he said.

Meanwhile the NIESR said the Government would meet its "golden rule" to balance the budget over the economic cycle.

It said recent upward revisions to economic growth meant the economic cycle would end this year, rather than next year as previously thought, which would leave the budget with a £7bn accumulated surplus.