The Bundesbank has said Germany is facing a residential property bubble, with homes overvalued by as much as a quarter in major cities.

In its monthly report yesterday it said prices in 125 German cities had risen 6.25 per cent compared to 2012 – driven by a lack of supply as well as by international demand for perceived safe investment in German bricks and mortar.

Overall, prices are up almost a fifth since 2010, the bank noted, an average annual rise of 5.25 per cent.

“In major cities the prices for residential property deviate by about 25 per cent,” said the bank, noting a 9 per cent rise in prices for apartments last year in Germany’s seven largest cities.

It is the bank’s loudest warning yet on the domestic property market since it first sounded the alarm in the autumn.

Bundesbank board member Andreas Dombret said yesterday prices remained manageable but conceded on German television that a bubble "can't be completely ruled out in the case of a long low-interest phase with such high liquidity".

After a long-term shortage of properties in urban areas, the bank said the supply of residential property was slowly improving. Greater efforts should be made to encourage investors back into the market, it added.

This would be more effective in moderating prices than planned regulatory ceilings to limit rental price rises, which the bank described as counterproductive.

Germany’s central bank insisted the property bubble did not represent an economic risk to Europe’s largest economy as there was no indication that borrowing was increasing to keep pace with prices. “Mortgage loans to private households rose moderately by 2.25 per cent, after 2 per cent in 2012,” the report continued, noting that banks had tightened up their mortgage guidelines.

Separate data issued yesterday showed residential house prices posted their largest leap in a decade last year.