Lehman puts housing crash risk at one-in-four

Lehman Brothers, the investment bank, added its voice yesterday to the chorus of experts warning of an imminent fall in house prices.

Economists at the blue-chip Wall Street bank said property prices could fall by 7 per cent between now and the end of 2007.

It said it expected the slide in prices to be gradual but warned there was a one-in-four risk of a repeat of the full-blown housing crash that hit the UK in the early 1990s. The housing values would force the Bank of England to slash interest rates back to the 50-year low of 3.5 per cent in the middle of 2003, it said.

Alan Castle, the bank's UK economist, said in an 80-page report that fundamental factors such as household income, mortgage rates, credit conditions, supply of homes and population changes all pointed to houses being 15 per cent overvalued.

He said he was forecasting that house price growth would be 2 per cent this year, followed by a fall of 3 per cent next year and a drop of 2 per cent in 2007.

"On the surface, this looks like a reasonably benign outturn, although it is probably worse than the 'soft landing' scenario that housing market commentators often refer to, where nominal prices flat-line for a number of years," he said.

The housing and mortgage industry has resisted claims that the housing market is on the brink of a crash, saying that with the economy close to full employment, there is no reason for homeowners to rush to sell.

But Mr Castle said it was impossible to rule out a 15 per cent drop in prices, which would qualify as a "crash" on a par with the 1990s downturn.

He said that a hit to incomes from higher taxes and a negative "frenzy" effect on prices after the recent "irrational" rise in prices could deliver a steep drop. "We would attach something like a 25 per cent probability to that," he said.

Either way, Mr Castle said consumers would rein in their spending, dragging GDP growth down to 2 per cent and prompting the Bank to cut rates as low as 3.5 per cent.

"The point we are making is that there is a medium-term view distinct from the near-term dataflow," he said. "The Bank may be fine-tuning policy now but beyond that horizon we think rates will peak soon and come down quite quickly."

New housing figures pointed to a continued slowdown in the property market. The Royal Institution of Chartered Surveyors reported another month of price falls in February, albeit at the slowest pace for five months. Its members envisage modest price falls in the coming months.

Meanwhile the Office of the Deputy Prime Minister said that house prices rose in January at the slowest annual pace since April of last year.

The average price of a home rose 10 per cent, down from December's 10.7 per cent. Prices fell 0.1 per cent in the month to an average £178,796.