House prices could stall completely in 2005 and 2006 as the market struggles with higher interest rates, falling rental yields and weakening demand, a leading market analyst has predicted.

Mr Seamus Murphy, a banking analyst with Merrion Stockbrokers, said yesterday that he was expecting house prices to post zero growth in 2005 and 2006.

Taking inflation into account, this would represent a drop in the real value of existing properties.

Mr Murphy said he had run a sensitivity model on the housing market and its consequences for banks' mortgage books.

His prediction of zero inflation comes as the latest Permanent TSB/ESRI survey on house prices reveals that growth in prices continued to moderate in July. The index, published on Monday, pointed to house-price growth of 5.7 per cent in the first seven months of the year. This compared to growth of 11.4 per cent in the 12 months to the end of June.

One potential strain facing the market, according to Mr Murphy, is the cost of borrowing, which is expected to begin rising over the next six to nine months.

Market consensus suggests that euro-zone rates could increase from 2 to 3 per cent over the coming year.

Lenders would pass on any such climb to their mortgage customers, thus increasing the cost of funding property purchases.

Mr Murphy also highlighted declining rental yields as a negative driver in house-price inflation. He said the after-tax return on rental properties was now about 2 per cent, leaving little real financial gain for investors.

Buy-to-let borrowers have, according to some estimates, accounted for close to one-third of new mortgage lending over the past year but this is now expected to tail off.

Mr Murphy's analysis is also based on the supply of housing continuing to outstrip demand over the next two years.

Davy Stockbrokers recently predicted that some 80,000 new houses would be constructed this year. Mr Murphy believes however that "natural" demand exists for just 45,000 houses.