HONG KONG - The International Monetary Fund said Tuesday that Hong Kong faced a potential surge in property prices and endorsed a government plan to cool any overheating in the market.

The Washington-based organization's warning came as prices in the southern Chinese city soared with luxury developments up more than 40 percent since January this year.

Concerns about the price spike -- largely driven by mainland Chinese buyers -- peaked last month when a luxury flat sold for US$57 million dollars, a world record at US$11,300 per square foot.

The Hong Kong Monetary Authority (HKMA), the city's de facto central bank, told local banks to cap home loans in a bid to curtail speculative buying. The government also warned that it may intervene by increasing land supply in the densely populated city of seven million people.

"We welcome the consideration that is now being given to increasing the supply of land to the market as one of the possible means to help moderate potential property price surges," the IMF said in a report on the city's economic health.

Meanwhile, the IMF raised its growth forecast for Hong Kong, saying the region's economy would likely contract two percent this year – down from its earlier 3.5 percent forecast – with five percent growth in 2010.

"The recovery is now underway," it said.

Hong Kong's banking system weathered the global financial crisis and was now "healthy, liquid and well capitalized," the report said.

The organization also backed the city's currency peg to the US dollar as an "anchor of monetary and financial stability."

The HKMA has injected billions of dollars into the foreign exchange market in recent months to keep the Hong Kong dollar within its required trading range against a weakening US dollar.