Update Capital city home prices rose by a record 20 per cent in the year to the end of March, giving the Reserve Bank more reason to lift interest rates tomorrow.



For the quarter alone, home prices rose 4.8 per cent, easing from a revised 5.1 per cent recorded for the December quarter, the Australian Bureau of Statistics said today. The annual pace compared with the revised 13.5 per cent gain for all of 2009, indicating house price increases are accelerating.



''I think the RBA will take notice of the acceleration in what is essentially house price inflation,'' Citi economist Josh Williamson said.



The Reserve Bank is rated a two-in-three chance of lifting its key cash rate to 4.5 per cent from the current level of 4.25 per cent when it meets tomorrow, according to financial markets. Such an increase would be the sixth rise since October when the RBA changed course and made rising cost prices rather than slowing growth its main focus.



The latest report on surging home prices comes a day after the federal government released the Henry tax review, which recommended a broader land tax to replace stamp duties. It also called for a reduction to negative gearing tax rates, which are blamed by some for distorting the real-estate market to favour owners over buyers and renters. The government, however, shelved or rejected such recommendations, instead revealing plans for extra mining taxes among other changes.



The gain in the year to March was the most since the current statistical series began in 2002, according to Bloomberg data. An earlier ABS index of established homes hasn't recorded such a big increase in annual prices since the year to March 1989.



''This is certainly an indication of a buoyant economy at least for those who can afford a house,'' Mr Williamson said.



Home prices have also been driven by a swelling population and a shortage of affordable housing.



Melbourne price surge



Among the capitals, Melbourne led gains both on a quarterly and annual basis, with prices rising 6.7 per cent and 27.7 per cent, respectively.



In Sydney, prices rose 21 per cent for the year and 5.3 per cent for the quarter. Perth's annual prices jumped 15 per cent, and 3.5 per cent for the quarter.



Brisbane's prices, meanwhile, rose 12.1 per cent for the year and 2 per cent in the quarter.



''It's a massive increase in the house price index,'' said Arab Bank Australia's David Scutt. ''Lock in another rate hike tomorrow.''



The surging home prices come amid signs of an economy expanding rapidly, fuelling fears of unsustainable growth.



TD Securities/Melbourne Institute monthly inflation gauge, released today, showed that, in the year to April, inflation increased 2.9 per cent - the most in 14 months. That tally also bumps up against the RBA's preferred maximum of 3 per cent.



Separately, the Australian Industry Group's Performance of Manufacturing index surged in April, rising to 59.8 from 50.2, showing that Australia's economic rebound is also being reflected in the building and infrastructure sectors.



Property puzzle



Analysts, however, said the sharp rise in home prices remains puzzling following five consecutive months of declining home-loan volumes.



Mr Scutt said the March quarter price rises, viewed against the slump in home loans, ''adds support to the foreign ownership talk that had been persistent over previous months''.



The government tightened the requirements on foreign ownership last month, after loosening them early last year. The easier restrictions reportedly prompted a flood of overseas investment into the Australian real-estate market.



But the exact impact of the rule change on Australian city home prices was not measurable because the government stopped keeping data on the transactions over the period.



''The crucial issue in gauging the price outlook from here is how we resolve the growing discrepancy between depressed home-loan demand and frothy dwelling prices and market activity,'' JP Morgan economist Ben Jarman said.



Either foreign demand for homes had boosted prices, or a smaller number of home buyers were continuing to borrow sizeable amounts, he said.



Auction clearance rates remain above 80 per cent in Melbourne despite the recent changes to foreign investment rules and higher interest rates.



''It is important to note that the ABS's house price index, which reflects sales for detached houses in capital cities only, probably overstates true economy-wide dwelling prices,'' Mr Jarman said.



''Also, the housing market indicators of late have painted a more mixed picture than implied by today's report, with prices and general market sentiment buoyant but loan demand and building activity sagging.''



For example, RP Data's measure of national home prices adjusts for differences in the types of purchases between new home buyers and existing home upgraders.



National home prices in the year to March increased by 12.5 per cent, the research group said last week.



czappone@fairfax.com.au



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