Despite a nearly two-year slump, Sydney home prices remain overvalued, according to SQM Research.

Numerous signs suggested that the market had bottomed out and a price surge was imminent. The city is set to experience a 2% increase in home prices in September and another 4% surge over the December quarter, according to forecasts.

Factoring in the price declines during the start of the year, these increases would leave prices an average 1% higher than they were last year.

However, the market remained 21% overvalued relative to the size of the economy, according to SQM Research director Louis Christopher.

 “This is all based on our view that there is a relationship between nominal GDP and house prices. Logically, there should be a relationship. Housing price rises cannot outpace income growth forever. And the more the gap(s) between the two, the more housing prices have to be supported by cheaper and easier access to credit,” Christopher said.

The overvalued market would pose challenges for policymakers if prices were to climb rapidly again.

“Left unchecked, we could soon be heading towards yet another historic overvaluation point similar to levels recorded in 2003 and 2017,” Christopher said.

During the prices’ peak in 2017, regulators introduced lending restrictions to bring down values, avoiding a market crash. However, regulators may not take the same action in the future if unemployment rose or the economy experienced other signs of weakness.

“They may well let the market run,” Christopher said.