House price rises 'will grind to a halt' as interest rates bite

Unrelenting rises in house prices are finally expected to halt, dropping from well over 10 per cent today to less than 1 per cent by the end of next year, the Ernst & Young ITEM Club forecasts.

Houses are currently overvalued by as much as 16 per cent, it warns.

An interest rate hike to 6 per cent will end the property market boom, ushering in a decade of stagnation, it says.

As householders are squeezed, the Treasury appears to be enjoying a boom.

Tax payments rose almost 10 per cent in the first quarter this year, compared to the same period last year, dramatically outstripping growth in wages and salaries of only 5.1 per cent.

According to experts, the Chancellor's 'trick' of fiscal drag is to blame for the rising tax burden. This is the policy of raising the tax threshold more slowly than earnings are rising. As a result, workers end up paying a higher proportion of their income in tax.

According to the ITEM Club's quarterly outlook, the downturn in the property market will be fuelled by high interest rates, which, it predicts, are likely to remain at or around 6 per cent until 2012.

Such an increase will dismay first-time buyers, who have watched rates rise five times in a year and are struggling to get a foothold on the property ladder. They currently stand at 5.75 per cent.

The rise would mean an additional £300 a year in costs to those on a £150,000 25-year repayment mortgage, taking annual repayments to £13,896.

The ITEM (Independent Treasury Economic Model) Club is a respected economic forecaster, which correctly predicted the property boom in 1998.

This is the first time that it has raised fears about the buoyant housing market and although there have been fears of a crash, the report claims the market will simply freeze.

By the end of this year, it predicts annual house price inflation will slow to 7 per cent and then steadily drop to below 1 per cent by the end of Peter Spencer, the ITEM Club's chief economic adviser, said: 'One thing you can be sure of is the housing boom has got to stop, and we will get whatever level of interest rates is necessary to do that.

'By the end of next year house-price inflation will be flat or negative.

'It now seems clear that we are all going to have to get used to a period of significantly higher interest rates.

'What happens then depends on whether people take heed of these rate rises and adopt a more cautious approach to their personal finances.'

He added: 'Tax payments are growing roughly twice as fast as pre-tax incomes. That's a staggering indictment of the tax system. It basically means that (the Chancellor) can sit back and watch the money roll in.

'Fiscal drag is bearing down heavily on disposable incomes, pushing the tax burden up to record levels.'

The effects of fiscal drag are not just confined to income tax.

Rising house prices have brought the Treasury billions more in stamp duty and inheritance tax.

The Government has refused to move thresholds for both to bring them in line with house prices, dragging hundreds and thousands of buyers over the higher tax threshold.

A Treasury spokesman attributed the rise in tax payments on record City bonuses this year.

He said: 'It is misleading to claim that households have experienced such an increase in tax payments.

'In fact, this data is heavily skewed by a small minority who have received City bonuses, which recently recorded record levels.'