The Reserve Bank fears that the huge demand among property investors for Australian homes could ultimately cause prices to slump.
Investors have been driving housing demand in recent years, particularly in Sydney and Melbourne, pushing prices to record levels.
In NSW, investor loan growth has more than doubled in the past three years and now accounts for almost half the value of all housing loan approvals in Australia's largest state, the RBA said in its bi-annual Financial Stability Review on Wednesday.
The central bank fears that the heightened investor demand will push prices even higher but ultimately cause a sharp drop as demand for properties falls away because prospective buyers are priced out of the market.
"Ongoing strong speculative demand would tend to amplify the run-up in housing prices and increase the risk that prices in at least some regions might fall significantly later on," the review said.
"Importantly, a future fall in housing prices would reduce wealth and dampen spending for the broader household sector, particularly for those households with significant housing debt, not just for the investors who contributed to the upswing."
The RBA also warned that a looming oversupply of dwellings, particularly in Melbourne, could push down prices.
"The rental market already looks fairly soft, with relatively high vacancy rates and little growth in rents," the RBA said.
Brisbane was similar, with a strong increase in higher-density dwelling approvals and some reports suggesting vacancy rates were drifting higher.
The RBA was optimistic that the Australian Prudential Regulation Authority's recent tightening up of rules for investor loans will ultimately blunt any risk to the wider economy.
But it said it was too early to expect a material slowing in investor loan approvals, partly because there was a large pipeline of pre-approvals when the measures were announced in late 2014.
In the meantime, the RBA does not believe mortgage lenders have loosened their standards at a time when borrowers have access to record low interest rates amid intense competition in the loans market.
Indicators of overall household financial stress also remained low.
ANZ senior economist Felicity Emmett said she expected the RBA would still cut its cash rate to a fresh low of two per cent in April, while relying on APRA's measures to take the heat out of the more speculative elements of the housing market.
"Localised speculative elements in the housing market have been apparent for some time now, and given that they didn't stand in the way of the RBA kicking off a fresh easing cycle in February, we expect that will continue to be the case," she said.
CommSec chief economist Craig James said the RBA knows that further rate cuts could add to already strong housing demand.
"Another cut in rates increases risks that problems in the financial system may spill over into the broader economy," he said.
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