House prices in Britain are overvalued by about 30 per cent, the HSBC said yesterday, sounding the alarm that the property market could suffer a similar slump next year to that experienced in the US.

The alarming report from the bank’s chief UK economist, which gave warning that the coming property downturn would cause sterling to plummet and force the Bank of England to slash interest rates aggressively, came as official data revealed the fastest fall in London house prices for more than two years.

HSBC tried to model the fair value of housing based on expected future rental growth. Karen Ward, the report’s author, said: “There is around 30 per cent of the current house price level that cannot be explained.”

The findings echo those of the International Monetary Fund which last month calculated that homes in Britain were overpriced by up to 40 per cent.

The credit squeeze would now prove the trigger for Britain’s housing slowdown, HSBC argued. Higher mortgage costs would spark repossessions and make buy-to-let a poor investment. “A major source of demand in the past couple of years could then turn into a major source of supply,” the report said.

A slowdown in residential construction and consumer spending would then follow, causing growth to fall to its lowest level in a decade, the report said.

HSBC is now predicting that interest rates will fall far lower than the market expects, from 5.75 per cent at present to just 4.5 per cent by the start of 2009, while sterling is tipped to tumble against the dollar to below $1.80.

Ms Wardsaid that Britain’s spell of house price inflation, which had seen prices treble in the past ten years, had begun as a rational response to the improved economic climate following independence for the Bank of England.

“But as global investors and UK households shied away from corporate equities following the equity crash in 2001-02, they noted the rapid gains in UK property prices,” she said. “With the expectation that house prices would continue to rise rapidly, and a banking system awash with cash and willing to lend, the buy-to-let market boomed. That, in turn, led to expectations of further price gains. The bubble was born.”

Contrary to the view that supply shortages have forced up prices, Ms Ward argued that UK home starts had picked up since 2000 by the same amount as in the US, which is now grappling with a glut of properties and falling prices. Had there been a true supply shortage, rents would have been pushed up, but rental growth had in fact been mild, she added.

The grim report for homeowners was released as official figures showed that house prices in London dropped at their fastest pace in more than two years in October. The Land Registry, the most comprehensive source of house price data, said that property prices fell by 0.6 per cent in October in London, adding tofears of a housing slowdown in the year ahead.

While price rises in most other regions of England and Wales helped the overall average increase by 0.1 per cent, the sharp drop in London set warning bells ringing as the capital’s property market usually plots a course for the rest of the country. It was the first monthly fall since April 2006 and the sharpest such drop since August 2005, the figures revealed. Prices were up by 8.1 per cent over the year, the Land Registry said, the slowest rate of property inflation since December last year.

The authority’s data, while more comprehensive than other surveys, are also less timely as they refer to the price of properties at the point of completion.

Analysts’ attention will now be focused on tomorrow’s survey from Nationwide, of prices at the point of exchange in November. The report is expected to point to a sharp decline in the annual rate of house price inflation, to 8.5 per cent in November from 9.7 per cent the month before.