Interest rates should go up, the think-tank says

Price growth will slow to single digits rather than suffering an early 1990s-style crash, the NIESR report said.

But the think-tank also said the Bank of England's Monetary Policy Committee (MPC) should raise interest rates from 4.5% to 5% when it meets next Thursday.

The rise was needed in order to keep a lid on inflation, the NIESR said.

The chances of a sharp market correction are greater if house price inflation does not cool soon Simon Kirby, NIESR economist

The NIESR forecast growth of 3.3% in 2004 and 2.7% in 2005 for the UK economy.

Strong economic growth in the UK and the many other parts of the world combined with high oil prices could result in steeper price rises, the think-tank said.

Rate rises are therefore needed, it warned, to "nip inflation in the bud" since it was set to rise above the government's 2% target in 2005.

'Soft landing'

The NIESR warned that house prices in the UK were now well above their long term sustainable level.

"The chances of a sharp market correction are greater if house price inflation does not cool soon," NIESR economist Simon Kirby told BBC News Online.

Nonetheless, the NIESR expected the housing market to come to a soft landing - with house price inflation of 9% during 2004 and 1.5% in 2005 - rather than endure an early 1990s-style crash, he said.

But he warned of a possible loss of at least a quarter of one percentage point of UK economic growth over the next four years should house prices fall dramatically.

On Thursday the Nationwide revealed that UK house prices increased by 2.1% in July.

Some experts believe that the Nationwide survey result increases the chances that the MPC will vote for a rise in interest rates.