Sydney is in the midst of a housing bubble but that won't stop the Reserve Bank cutting rates again, a top economist says.
Unjustified property prices and investor speculation has created a bubble in Sydney that's at risk of bursting, AMP chief economist Shane Oliver says.
Average prices in Sydney soared 13 per cent in 2014, almost double the rate of the next strongest city Melbourne, and are not slowing down, rising three per cent in March.
Other capital cities aren't off the hook either - property prices are overvalued across the country, Dr Oliver says.
"Sydney looks a bit bubbly, there's a bit of a mania going on in Sydney," he told AAP.
"The risks of a bust are certainly there."
But the RBA will still cut the official interest rate in May, and there is a strong possibility of further cuts after that, Dr Oliver said.
Plummeting commodity prices, the high Australian dollar and a deteriorating outlook for business investment mean the RBA aren't short of reasons to cut.
Although Sydney property prices are a concern for the RBA, the central bank needs to cut rates for the good of the wider economy, and allow the banking regulator to contain any housing risks, Dr Oliver said.
Property prices are overvalued because of a chronic undersupply of new homes, which pushes up the price of the existing ones, he said.
Sydney's bubble probably won't burst, but prices will likely fall five to 10 per cent in a couple of years, once interest rates start rising again, he predicts.
"The more likely scenario is that we go through a long period of wobbly prices ... without really growing but without really busting," Dr Oliver said.
"I think at some point, two years down the track, after the interest rate cycle turns again, Sydney and Melbourne will see price falls.
Dr Oliver says investors are better off parking their money in shares or commercial property, given current rental yields are about one per cent after costs.
And anyone depending on capital growth will probably be disappointed.
"Investors certainly shouldn't bet on recent price gains being sustained - that would be a highly dangerous assumption," he said.
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