House prices rising at fastest annual rate for two years

House prices shot up in December at their fastest annual rate for two years, bolstering the case for an interest rate rise early in the new year.

A rise of 1.2 per cent in December brought the annual growth rate up to 10.5 per cent, figures from Nationwide, the country's biggest building society, showed. This meant the price of an average house increased by £45 a day in 2006, three-and-a-half times faster than during the previous year.

Economists warned that the double-digit rate of increase - the first since February 2004 - would set alarm bells ringing at the Bank of England. The latest set of minutes from the Monetary Policy Committee singled out the strengthening housing market as an upside risk.

The rebound in prices this year caught most economists on the hop, not least Nationwide which entered 2006 predicting annual growth would be 3 per cent at best.

For 2007, Nationwide believes the rate of growth will be "relatively robust" at between 5 and 8 per cent; Halifax, the biggest mortgage provider, is predicting growth of 4 per cent; the Royal Institution of Chartered Surveyors' estimate is 7 per cent.

Fionnuala Earley, Nationwide's group economist, said: "There are still few signs that the rate of house price growth will moderate in the very short term. Evidence from estate agents continues to show that supply conditions are tight with fewer sellers coming to market."

Giant bonuses are fuelling housing demand in London and the South-east, while elsewhere in the country the rise in population, boosted by the inflow from eastern Europe, has kept prices high. The average price of a house hit £173,746 in December, up from £172,185 in November, Nationwide said.

The strong finish to 2006 surprised some economists who had thought that two interest rate rises since August would take some steam out of the market. Howard Archer, at Global Insight, said: "Although the current strength of mortgage activity indicates that August's interest rate rise at least had little immediate cooling effect on the housing market, it is too early to judge whether or not November's further increase in interest rates will have a significant dampening effect."

He warned that a further 25-basis-point rise to 5.25 per cent could "ultimately have a substantial dampening impact on housing market activity", with "so many people stretched to the limit".

Ms Earley said the double whammy of recent rate rises and worsening affordability would cause the rate of house price growth to move back into single digits in the second half of next year.

Despite the inflationary build-up in the economy, Nationwide said it stuck with its view that rates have peaked at 5 per cent.