HOUSE-HUNTERS should beware before they plunge into the market because of the growing risk that prices will drop, the Governor of the Bank of England said last night in his toughest warning yet on the property boom.

Mervyn King said that first-time buyers and those seeking to move should act with caution: “Anyone entering or moving within the housing market should consider carefully the possible future paths of both house prices and interest rates.

“After the hectic pace of price rises over the past year, it is clear that the chances of falls in house prices are greater than they were,” he said in a speech in Glasgow.

His warning coincided with a report showing that the rising cost of borrowing was already scaring buyers away before last week’s rise in interest rates.

Treasury officials said last night that the Governor was right to be alert to the risks.

Ministers are believed to be more sanguine about the outlook for prices as a result of the study on housing supply by Kate Barker, a member of the Monetary Policy Committee. Ministers have looked at the experience of the Netherlands and Australia, which, after steep and sustained price rises, later returned to more gentle trends without a property crash.

According to the May survey by the Royal Institution of Chartered Surveyors (RICS), numbers of new buyers dropped in May for the first time since December, recording the sharpest fall since the Iraq war. Sales fell to their lowest since last September.

“Optimism is at its lowest level since July last year,” the report said. Estate agents in the South East and East Anglia believe that house prices are at their peak and expect “at best, a static market” over the next few months.

The number of properties for sale is also at its lowest for 25 years, increasing the risk of volatility. “Last year house prices rose 15 per cent on a 15 per cent fall in turnover,” Richard Donnell, director of research at FPDSavills, said. “That is a classic example of market volatility on thin volumes.”

Mr King said that after more steep gains in recent months, house prices were “now at levels which are well above what most people would regard as sustainable in the longer term”.

He had already detected “some early signs, from surveys, of a slowdown in the market”, he said. Today’s RICS report is the third to suggest that this year’s surge in prices is petering out. In London and the South East price rises have fallen back to winter levels. In other regions, prices are rising at their slowest for six months.

The stark comments from the Governor came just days after the Bank raised interest rates for the second successive month to 4.5 per cent, in the first back-to-back increase for more than four years.

But despite his anxiety over the housing market, Mr King left little doubt that more rate rises are in prospect and steeled the country for yet-higher borrowing costs.

With a potent world recovery under way, Britain would enjoy “robust” expansion over the next year, Mr King told Scottish business leaders at a CBI dinner. But in a clear signal of further base-rate increases, the Governor said that, with little slack left in the economy, strong growth would mean growing price pressures.

“That continued strength, if left unchecked, is likely to put upward pressure on inflation, taking it over target in the medium term . . . cost pressures are increasing, and pay growth has picked up.”

The Governor added that it was “impossible to say” how far interest rates would rise. “There is no pre-determined plan. We examine the outlook afresh each month and keep an open mind.”

Mr King’s worries over house prices come before his first speech to the City as Governor at the Mansion House tomorrow, when he will expand on his outlook for the economy.

The International Monetary Fund gave warning in April of a “speculative component to house prices” in Britain, which was later dismissed by Gordon Brown, who yesterday became Britain’s longest-serving Chancellor.

Opposition parties also stepped up their cautioning over the housing market yesterday. Vince Cable, the Liberal Democrats’ Treasury spokesman, accused banks and building societies of “recklessly fuelling the housing boom”.

“Large numbers of people are gambling on the house price boom — a gamble they may regret if house prices start to fall or interest rates continue to rise,” Dr Cable said.

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