London's "booming and probably overheating" housing market arguably poses the greatest threat to Scotland's economic recovery, a new report has warned.

Economic expert Professor Brian Ashcroft of Strathclyde University cautioned that the Bank of England must avoid increasing interest rates as a way of dealing with the rising property market in the South East, as this could result in the recovery across the UK being "dampened".

He was speaking as the economic think-tank the Fraser of Allander Institute published its latest commentary on Scotland's economy.

Loading article content

While the think-tank, which is based at Strathclyde University, said Scotland is now enjoying a strong recovery, it also warned there are still risks from an "unbalanced recovery, falling real wages, booming house prices in the London housing market and deflation in the eurozone".

Its report stated: "Arguably the biggest threat to the recovery in both Scotland and the UK comes from the housing market. House prices are rising at an annual rate of 8% in the UK but by 17% in London. Scotland's house prices were largely flat over the year to March 2014 with growth of only 0.8%."

It called on the Bank of England to act by curbing high loan to income ratios, but stressed: "The Bank of England should not seek to raise interest rates largely on this account."

The report added: "There is a strong feeling, though, that the booming and probably overheating London housing market - as well as the strength of the labour market - is driving the Bank's gradual movement towards increasing interest rates. The Governor signalled in his recent Mansion House speech that the first rise could now come during 2014, whereas most analysts had expected the rate to rise in 2015.

"Rising house prices are essentially a London and South East England phenomenon. In Scotland, house prices are hardly rising overall. So, it would seem wholly inappropriate for the recovery to be dampened right across the UK to address what is clearly a local or regional issue centred on London."

Prof Ashcroft said: "It is the boom in the London housing market that causes us most concern. We believe the Bank of England must avoid raising interest rates on that account. With Scottish house prices hardly rising at all, it is inappropriate for the recovery to be dampened across the UK for what is clearly a local or regional issue centred on London."

The economics expert warned that the risks to economic recovery had "widened and deepened", stating: "Household spending is too reliant on further borrowing as real wages have fallen, net exports continue to contribute little to growth and business investment is only just beginning to pick up."

The economic commentary, sponsored by professional services firm PwC, warned the recovery "continues to be considerably weaker than that of any recession in the last 70 to 80 years (ie since the 1930s)".

It also stated that the key financial services sector, when taken on its own, "remains weak with output falling in the final quarter of the year to stand just above -12% below its pre-recession peak".

While the report said the recovery in the jobs market in both Scotland and the UK is "almost unprecedented", it added that there is still "plenty of slack for growth in the Scottish labour market".

The report said: "It is clear that growth in employment is still being sustained by the growth of part-time work and the self-employment. Moreover, there are still a large number of part-time workers who are seeking and cannot find a full-time job."

Overall it stated: "The evidence suggests that the UK and Scotland are still a long way off from a balanced recovery."

The think-tank is forecasting Scottish GDP will have growth of 2.5% this year, with this falling slightly to 2.2% next year, before picking up to grow by 2.4% in 2016.

It also anticipates jobs in Scotland will increase by 43,100 in 2014 and then by 42,900 the following year and 58,150 in 2016.

It projects unemployment total will be 173,150 by the end of this year, and will fall further to stand at 168,150 at the end of 2015 and then drop again to 157,200 by the end of 2016 as economic growth strengthens.

Finance Secretary John Swinney said: "These latest independent forecasts from the Fraser of Allander Institute (FAI) revise up expectations for Scottish growth in 2014, which is testament to the strength of the performance in the Scottish economy, as well as the optimistic outlook for business. The FAI also expects Scottish unemployment to continue to fall over the forecast period as more jobs are created in the economy.

"The forecasts highlight the increasingly positive outlook for business investment, and build on last week's survey of inward investment from Ernst and Young, which again showed Scotland as the best performing UK location outside of London for overseas investment projects.

"They also follow the ITEM Club's independent forecasts earlier this week, which predicted that 2014 is set to be the best year for Scotland's economy since the global financial crisis. In addition, recent labour market statistics show improvements across all headline indicators in Scotland both over the quarter and the year, and Scotland is outperforming the UK as a whole in terms of employment and inactivity."

But he added: "It is only with the full powers that are available to us under independence that we will be able to take the decisions required to grow our economy and increase Scotland's competitiveness."

Scottish Secretary Alistair Carmichael said: "Today's Fraser of Allander Institute economic forecast shows that as part of the UK, Scotland's economic recovery continues to go from strength to strength.

?ª?¬"By sticking to our long term economic plan, we are creating a better and more financially secure future for hardworking Scots and their families. This is reflected by today's report showing economic growth and job creation continuing to increase. This builds on last week's strong labour market performance which showed falling unemployment, record levels of Scottish female employment, record levels of Scottish private sector employment and confirmed that nearly 243,000 more Scots are working in the private sector than in 2010.

"Scotland benefits from the UK's larger, stronger and more stable economy and being part of the diverse UK single market with no borders or barriers. Together with the UK's international influence, these factors are ensuring our companies can excel both at home and abroad. In the years ahead this will continue to create better opportunities and more secure jobs in Scotland."