Rate rises start to bite as house prices stutter

House prices posted their smallest increase for eight months in January - the clearest signal yet that higher interest rates are taking the steam out of the property market.

The average price of a home rose by just 0.3 per cent to £173,225, according to Nationwide, the building society. That pulled the year-on-year rate of increase down to 9.3 per cent from 10.5 per cent in December.

Separate figures from the Bank of England showed mortgage lending rose in December at its fastest rate since records began in 1993, leaping by £10.58bn. But crucially, mortgage approvals - a reliable forward-looking indicator of housing market strength - dropped sharply to 113,000, the weakest since April.

Fionnuala Earley, Nationwide's chief economist, said: "It is likely that we will now begin to see a weakening in demand as a result of stretched affordability and rising interest rates." But Ms Earley said the market was on course for a soft landing rather than a Nineties-style crash. "The main risk is that sentiment and expectations change abruptly in response to the rate rises, leading to a severe loss of confidence. However, the more likely outcome is that the market will remain fairly stable but slow a bit more quickly than we initially expected. This would bring our expectation of house price growth in 2007 into the lower end of our 5 to 8 per cent forecast," she said.

The reports add to mounting evidence that the long-running housing boom is petering out in response to three quarter-point rate rises since August, which have added about £48 to the monthly bill of a £100,000 repayment mortgage. Last week, the British Bankers' Association said mortgage approvals in December were down 11 per cent on a year earlier, while the Royal Institution of Chartered Surveyors reported a sharp drop in house price growth in December.

Kelvin Davidson, property economist at Capital Economics, said: "As the market enters what is traditionally its busiest period, some rebound in mortgage approvals over the next two to three months cannot be ruled out. However, the unexpectedly sharp drop in approvals in December suggests there has been a genuine shift in buyer sentiment."

London has been the housing market's engine of growth, boosted by City bonuses and a lack of supply, and latest reports suggest it is continuing to power ahead, bucking the slowing trend elsewhere. Hometrack, the housing information business, reported earlier this week that prices in the capital were rising twice as fast as the national average.

Meanwhile, the Bank of England also revealed that consumer credit - borrowing on credit cards, store cards, unsecured loans and overdrafts - was muted in December, rising by £1.029bn against monthly averages of £1.6bn in 2005 and £2.1bn in 2004. Howard Archer, an economist at Global Insight, said: "This is clearly a consequence of consumers striving to curb their use of credit cards, or finding less expensive ways of financing their spending by switching more to secured borrowing."