Bank of Ireland expects the property market to peak this year before cooling down in 2007 as higher interest rates take effect.
The bank has raised its forecast for house price inflation from 9 to 12 per cent as the key drivers of employment growth, wage inflation and population are proving stronger than previously thought.
However, the bank predicts that breakneck pace of growth will slow towards the end of the year as affordability deteriorates with mortgage holders really feeling the pinch of higher borrowing costs in 2007.
Dr Dan McLaughlin, Bank of Ireland's chief economist, said although the property boom has been surprisingly prolonged, affordability will soon become a problem for many buyers.
"The average new mortgage on our affordability model will then cost 37 per cent of average earnings to service, and so price inflation may well slow to 3 per cent, implying zero growth in real house prices," he said.
The review notes that competition on the lending side has intensified, leading to the phenomenal growth in 100 per cent mortgages, but these products will offer only short-lived relief to borrowers, Dr McLaughlin said.
Dr Dan McLaughlin
"These measures can offset the impact of higher rates for a time but we retain our view that affordability will become a more significant factor in the market, particularly in 2007 when the European Central Bank's rate may rise to 3.5 per cent," he said.
Lynda Carragher, head of credit and risk management at Bank of Ireland Mortgages said: "The pace of mortgage lending reflects the buoyant demand in the Irish housing market, with a record 108,000 mortgages paid out in 2005 and likely to rise to 120,000 this year.
"The size of new mortgages is also rising of course, averaging 200,000 last year with a figure of 220,000 likely in 2006. This would give total new mortgage lending of 26.5 billion, up from 21.5 billion last year."