The International Monetary Fund has sent a stern warning to Australia about its over-priced property market, saying house prices are inflated by between 5 and 15 per cent.

The new report on Australia’s medium term economic outlook is more pessimistic than that of the Reserve Bank, which has indicated that it may raise interest rates sooner rather than later because the economy is travelling so well.

The IMF's April edition of its World Economic Outlook argues Australia’s property market is the fourth most vulnerable in the world to a painful price correction.

The IMF has issued the sharp warning, saying high and rising levels of household debt make Australia vulnerable to a sudden collapse in the confidence of global investors.

After examining increases in Australian house prices between 1997 and 2007, the IMF concluded the price rises are not explained by drivers such as higher incomes or low interest rates.

It found the gap between house prices and underlying value fundamentals is close to 25% in Australia, with only the housing markets in Ireland, Netherlands and the United Kingdom in a worse condition.

It is not inevitable that Australia’s property bubble will burst, the IMF says, as rising incomes and moderate inflation could see real property prices fall in a more measured way.

"Australia's persistent current account deficit, sizeable short-term external debt, and the worsening households' balance sheets were seen as vulnerabilities" the IMF's report said.

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