Home for Waters was Neyland in Pembrokeshire, on the south-west coast of Wales a place literally and figuratively on the margins of British life.

"It was a place of contradictions, it was held in a mid-20th century timewarp. It's given me a taste for small-town life, families, the slightly claustrophobic. I remember all the women looking old." The family weren't big readers, but Waters and her Dad enjoyed creating their own stories. As a teenager she developed an insatiable appetite for fiction.

Her first novel, Tipping the Velvet, made a quiet debut on Australian bookshelves in 1998 but word of mouth crept around and the book suddenly took off. She was in Sydney last month for the writers' festival. The idea for Tipping the Velvet emerged as Waters completed her thesis on lesbian and gay historical fiction. "I really got into the issue of what lesbians and gay men can do with history, whether you can reclaim it, recover it or invent it. I was finishing the thesis and I really began to think, there's a novel somewhere in here." She set out to develop a range of complex lesbian characters and identities that might have existed in the late Victorian era.

On contemporary lesbian fiction, Waters recalls an exciting time in the '80s with the emergence of lesbian publishing houses. "I remember reading lesbian novels in the '80s that weren't brilliant, but it was exciting that they were there at all." By the end of the '80s, lesbian fiction, says Waters, "had got a little tired". She credits authors such as Jeanette Winterson, Ali Smith and Emma Donoghue for invigorating the genre in new ways.

Tipping the Velvet tells, in a completely infectious and robust way the story of Nancy King, an oyster girl who falls passionately in love with a male impersonator, Kitty Butler. Eventually, Nancy evolves into Nan King and struts the music halls from Kent to London dressed as a man. A change of fortune forces a loveless Nan to London where she collides with a seedy underworld of predatory lesbians and prostitution.

The novel manages to satisfy both straight and queer audiences because at its core it remains a compelling, well-crafted story. In less skilled hands, this lusty tale of a cross-dressing lesbian in Victorian England could have been the literary equivalent of a The Benny Hill Show skit. Instead, Waters produced a melodramatic novel about lesbian desire, identity, and the length people go to in order to find love.

Waters admits to being fond of Victorian England. "You can look back and really see the beginnings of modern lesbian and gay communities happening. All the naughty '90s and the queer underworld. It made me want to look into other forms of lesbian passion and desire."

In some ways Tipping the Velvet outed her to her family and home town. "It's been very interesting. I wasn't sure how that would work but my family loved the fact I was in the papers that kind of eclipsed the lesbian part, so they liked celebrity, more than they disliked, if indeed they do, the queerness."

While much of the research for Tipping the Velvet took place during the writing of her thesis, other details needed to be explored, such as quite a lot "about 19th century pornography, Victorian sex aids, oysters, music halls, socialism, suffragism and general details about Victorian life". Asked how she would have coped being a lesbian during that period, Waters says it would have been a hard life, particularly if you were struggling. "There were lots of ways to satisfy lesbian passion, but not in ways we identify with now. The prevalence of women sharing beds, for example. If you were a servant you'd probably be sharing a bed with another woman whether you'd actually want to have sex with them, I don't know."

Creating Nancy Astley was a pleasure for her. "Her narrative voice is quite close to my own there's a lot of me in there, but she's different to me in lots of ways, too, but we have a similar take on the world."

With her second novel, Affinity, Waters again unleashed her taste for the Gothic to create a very different (but no less) entertaining account of Margaret Prior, a woman mourning the death of her father, and the fact that her former lover is now her sister-in-law.

Margaret is a haunted woman and spends her days taking draughts (on the insistence of her pushy mother) to ward off a depression that inspired an overdose of morphine. She decides to dedicate her time to a worthy cause and becomes a lady visitor at Millbank Prison. In a sense, she leaves behind one dark, oppressive, sexually charged place only to immerse herself in another. Here she meets spiritualist Selina Dawes, a beguiling woman charged with an erotic energy that quickly transfers itself to the willing Margaret.

Waters has done such a good job of evoking gloomy Millbank Prison the snaking corridors, the perpetual clanging of keys that it makes reading Affinity an almost multi-sensory experience. Waters says "the claustrophobic feel to Affinity was inevitable. I found it hard to go back to this grim world every day, everything sort of closes in on you. It's a book of interiors. You get a sense of a closed room". Again, lesbian desire is central to the theme, but the novel comfortably occupies a larger territory, ranging across subjects such as England's penal system, spirituality and notions of romantic power.

Set 30 years earlier than Tipping the Velvet, Waters found it difficult to write Affinity; partly due to the pressure of second-novel syndrome, and the depressing subject matter. "For one reason or another, they (the characters) can't take pleasure in the world. Most of their experiences are grim and bleak. With Margaret in particular, I was trying to get into the head of this upper-class Victorian woman, with her own particular history of depression. By the end, it was almost an act of ventriloquism." The possibility of supernatural involvement hovers over the storyline of Affinity like an impenetrable fog. Does Selina Dawes really have mystical powers or are Margaret's quietly hysterical episodes the real cause?

Waters admits to having a "Gothic take on the world. It's queer in both the general and the specific. I'm sure it goes straight back to my childhood. I can take quite a lot of horror but enjoy the kind that verges on the melodramatic". Ask Waters what she find truly frightening and her reply is surprising. Urban terror and the sinister elements that exist in city living scare her the most. "London is full of alienated people. They can be pushed to do macabre things. That kind of realism scares me. The Gothic genre is slightly more removed because it uses archetypes like 'the house', that kind of symbolism resonates for me."

In 2000, the book picked up the Somerset Maugham prize, the Sunday Times Young Writer of the Year Award and was short-listed for the Welsh Book of theYear Award. The BBC is currently negotiating television versions of Tipping the Velvet and Affinity. Screen writer Andrew Davies, who adapted Pride and Prejudice and Vanity Fair, is working on the scripts. Waters' was never tempted to try the adaptation, admitting "I just didn't feel equipped. It's a completely different art compared to novel writing".

Waters' fascination with Victorian England is far from sated. Her next novel (due for release around March 2002) is set in the 1860s and promises even more melodrama, intrigue and Gothic atmosphere. Wilkie Collins' Woman in White was an influential text "to the extent an heiress is cheated out of her inheritance and locked up in a lunatic asylum. It's told from the villain's point of view and begins in a thieves' underworld and then moves in and out of London".

Perhaps Waters is right, you can never really go back, but when a creative future looks this promising, maybe you don't need to.

Tipping the Velvet and Affinity are published by Penguin Books $19.95