A sharp rise in interest rates could trigger a slump in house prices, which are overvalued by "any conventional measure", the International Monetary Fund warned yesterday.
The world's chief financial watchdog warned that soaring prices posed one of the biggest risks to the UK economy.
"House prices in Spain, Ireland and the United Kingdom still look elevated, and could come under pressure in a rising interest rate environment," it said.
The fund's warning came as the Royal Institution of Chartered Surveyors revealed that house prices in the UK are now growing at the fastest pace since May 2004 as house prices accelerated for the fifth month running in August. The balance of surveyors reporting price increases in the past three months climbed to 30 per cent in August from 24 per cent in July.
The IMF also said the chances of another rate rise were "delicately balanced" and urged Gordon Brown to use next year's three-year spending review to cut expenditure to prevent a crisis in the public finances.
However, in a boost for the Chancellor, the fund raised its estimates for growth in the UK economy this year and next, putting it closer to the Treasury's upbeat forecasts for 2006 and 2007.
In its keynote World Economic Outlook, the IMF warned that a fall in house prices - which would leave households poorer - was a potential danger for many rich countries as it would lead to consumers tightening their budgets.
"A key risk on the demand side is that continued cooling of advanced economies' housing markets will weaken household balance sheets and undercut aggregate demand," it said. "At this point, concerns centre on the US, although other markets, such as those in Ireland, Spain and the United Kingdom, also still seem overvalued by most conventional measures."
This marks a harsher warning than its last forecasts in April when it said house prices had come closer to economic "fundamentals" - factors such as demand, supply and wages.
It also follows a raft of figures showing that house prices posted strong gains over the summer although the UK mortgage industry believes that the market will slow rather than embark on a renewed boom.
It raised its forecasts for GDP growth for this year to 2.7 per cent from April's estimate of 2.5 per cent and upgraded 2007 by 0.1 per cent to 2.7 per cent.
This leaves the IMF's forecasts above the 2.0-to-2.5 per cent range published in April's Budget, but below the bottom of the 2.75-to-3.25 per cent range for 2007.
The fund said that stronger growth had contributed to making the upcoming decision on interest rates by the Bank of England "delicately balanced".
"While risks to aggregate demand are skewed to the downside, particularly in 2007, there is also a possibility that energy price increases may yet give rise to second-round effects on inflation," the report said.
The fund fired another warning shot across the bows of the Treasury on fiscal policy. It said the budget deficit was set to narrow "slightly", reflecting strong revenues from higher energy prices and the booming financial sector.
But it urged the Chancellor to use next summer's spending review to tighten the public purse strings for the remaining years of the Labour government.
Hopes of an upturn in the labour market were dented by figures buried in the detail of the report showing that the unemployment rate was set to jump to 5.3 per cent this year from 4.8 per cent in 2005, although it would fall to 5.1 per cent next year.Reuse content