Worst-hit areas of the country will be those that suffer the heaviest public-sector layoffs

Homeowners should brace themselves for a "short, sharp shock", with house prices set to fall by up to 20% over the next two years as rising unemployment and public spending cuts take their toll, experts are warning.

The cost of the average home fell by up to one-fifth between mid-2008 and the end of 2009 as the credit crunch gripped the mortgage market, but then regained about half of that ground last year, aided by record low interest rates.

With the Bank of England's policymakers locked in an acrimonious public row about whether rates should start rising again to choke off inflation, analysts say prices now look too high to be sustainable.

"Prices are trending slowly downwards at the moment, but our view is that this is really the start of the second leg of the correction, and we expect prices to fall significantly further," said Paul Diggle, property economist at consultancy Capital Economics.

He calculates that the average home remains up to 20% overvalued by historical standards – and with the mortgage market still tight and unemployment rising, 2011 could bring prices crashing back to earth.

Andrew Brigden, of financial research group Fathom, agrees that homeowners can expect a rough ride. Fathom reckons house prices are 20%, perhaps even 30%, too high relative to average wages.

"I think the correction will come at some point, even if interest rates stay where they are, but if rates go up, that will hasten it," he said.

However, he believes there is another possible scenario in which it could be possible that prices will remain flat for many years to come, while wages gradually catch up.

The impact of any downturn is likely to vary across the country. Miles Shipside of property website Rightmove said prices in each area would be driven by the fortunes of the local population, with the worst-hit places likely to be those where public sector layoffs are worst.

"Forced sales will be the issue, so it depends on the make-up of your area – the level of unemployment and financial hardship," he said.

Rightmove's monthly survey, due to be published on Monday , will reveal a 21% increase in the number of properties coming on to the market in London, while the market in the rest of the country is "frozen over".

Simon Rubinsohn, the chief economist at the Royal Institution of Chartered Surveyors, echoed the picture of a market that has been stuck in a rut in recent months. "The vast majority of our members are saying that prices are pretty flat – they've been saying that since 2009."

The fragility of the housing market sharpens the dilemma facing the Bank of England's nine-member Monetary Policy Committee, which is engaged in a war of words about whether, and when, to tighten policy.

Mervyn King, the governor of the Bank of England, played down the need for a rate rise last week, but Andrew Sentance, the hawkish independent member of the MPC, publicly rebuked his colleagues, warning that they would find themselves "playing catch-up" unless they raise rates urgently.

With Sentance and the dovish American economist Adam Posen both due to make speeches this week, the schism at the heart of economic policymaking will be clearly exposed again.

The chancellor, George Osborne, will watch the debate at the Bank with trepidation, because the government has repeatedly stressed that its aggressive public spending cuts should make room for King and his colleagues to keep interest rates lower, for longer.

Any increase in borrowing costs would cause fresh pain for households already suffering what King has called the worst decline in living standards since the 1970s.