Houses 'are priced 65 per cent too high'

The Organisation for Economic Co-operation and Development revealed that UK property prices are among the most stretched of any major world economy.

At the same time, finance experts warned that the Bank of England could increase interest rates to 6 per cent before the end of the year.

The prospect will alarm homebuyers who are already struggling to meet their monthly mortgage payments after four hikes since last August. Annual payments on an average £150,000 mortgage are already £1,200 higher than this time last year.

The Paris-based OECD said it was worried about the valuations of homes in a range of countries following a world-wide boom.

It said a slowdown is long overdue and that a property crash cannot be ruled out.

Among the G7 club of rich nations, only Canadian properties are more over- stretched than the UK's levels.

If interest rates are not raised to slow down the economy, a major slump may do the same job - but with far worse consequences.

The OECD's report said: "Some slackening in the pace of of housing investment is likely in many OECD countries, and that may contribute to a cooling down of some fast-growing economies.

"There is always a risk, nonetheless, that it takes the form of a pronounced slump with, possibly, substantial knock-on effects to activity in the rest of the economy."

The research in the OECD's biannual Economic Outlook compared the price of the average house with annual rental incomes.

The measure is widely used by experts because if houses do not generate enough rent, then landlords will be willing to pay less for property, pulling down prices.

This indicator in Britain is now 65 per cent above its historic average since 1970.

An alternative-measure compares house prices with average annual incomes.

This shows that UK prices are 45 per cent higher than their long-term average, the OECD reported.

Ed Stansfield of research organisation Capital Economics said there are good explanations for Britain's decade-long house price surge, including lower borrowing costs and a shortage of new property on the market.

His own calculations suggest that the market is at least 15 to 20 per cent overvalued.

"We are in for a very, very subdued picture in term of house-price inflation and housing market activity," he said.

Despite fears for the housing market, the outlook for the UK economy remains buoyant, according to the OECD.

It predicted that gross domestic product will increase by 2.7 per cent this year, little changed from last year's healthy 2.8 per cent.

But it urged the Bank of England to be "vigilant" following a recent surge in inflation.

The OECD also criticised Chancellor Gordon Brown for failing to do enough to rein in public spending, calling for greater restraint.

Its estimates show that the UK's deficit will be higher than any other western European country this year, as NHS budgets soar and Mr Brown struggles to control public sector pay.

The figures compare public deficits with the size of overall economies across the 30-nation OECD.

In Europe only Hungary and the Czech Republic are experiencing a more dramatic deterioration in the public finances.

A Treasury spokesman said: "As this report shows, the UK has one the fastest growing economies in the G7 this year, and is forecast to grow faster next year than any other major European economy, building on a record 58 consecutive quarters of economic growth."

A poll of 62 economists by the Reuters news agency showed that one in three believed interest rates will hit 6 per cent this year.