AN influential Scottish think tank has cited the housing market as potentially the biggest threat to economic recovery in both Scotland and the UK as a whole, and urged the Bank of England not to use interest rates to cool residential property prices.

Professor Brian Ashcroft, economics editor of the Fraser of Allander Institute's highly-regarded commentary, warned that using interest rates to calm the rise in house prices would penalise people who were the most heavily-indebted and least well-off and could thus trigger a sharp fall in consumer spending.

In its latest economic commentary, published yesterday in conjunction with accountancy firm PwC, Strathclyde University's Fraser of Allander Institute says: "We have concerns about the impact on the UK, excluding London and the South East, and Scotland's economic recovery of the Bank's hypothetical use of its interest-rate lever to subdue the growing bubble in housing prices in parts of the UK, such as London."

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Mr Ashcroft expressed a preference for targeted measures to tackle surging house prices, such as measures to limit loan-to-value or loan-to-income multiples, with implementation of such moves perhaps "a little bit more tight" in London. He said: "We don't want interest rates to be used to dampen the housing market because it dampens the whole rest of the economy. It also discriminates against those people who are highly-indebted, those relatively less well-off people, and they are going to cut back on their spending as a result."

Mr Ashcroft also highlighted the potentially damaging impact on the economy if house prices were to fall sharply. He said: "We don't want house prices to grow too quickly. We don't want them to drop too quickly either ... . If house prices drop suddenly, again that will trigger a significant adjustment downwards in household spending."

Paul Brewer, an Edinburgh-based corporate finance partner at PwC, said: "The confidence [that] business is showing just now will get knocked pretty quickly if the consumer doesn't keep the head of steam they have got just now."

Asked if he saw signs of overheating of the housing market in Scotland, Mr Ashcroft replied: "It is not overheating in Scotland, although the latest figures which came out [this week] show that, in the year to April, Scottish house prices rose 4.8 per cent, [up from] 0.8 per cent in the year to March... . It is essentially a rest-of-the-UK problem, by and large."

He noted that house prices had risen by nearly 10 per cent in the year to April in the UK as a whole, and by 18.7 per cent in London.

Mr Ashcroft, while declaring in the commentary that the Scottish economy is now enjoying a strong recovery, warns that this is subject to the risks of a continuing lack of balance, falling real wages, and deflation in the eurozone, as well as "booming" house prices in London.

He adds: "The evidence suggests that the UK and Scotland are still a long way off from a balanced recovery. Investment does seem to be picking up and it is to be hoped that this will continue because the prospects of a marked improvement in the net trade position, with sterling high and the European economies weak, does not augur well.

"And while household spending is currently strong, its underlying determinants appear weak. A key reason for concern about the sustainability of household spending is that debt levels to income remain high and real wages are falling."

Mr Ashcroft said yesterday: "Investment is picking up but it is picking up slowly, maybe even more slowly in Scotland. Net trade is a drag [on growth] at the moment, so it is very unbalanced."

Bank of England Governor Mark Carney signalled last Thursday that the first rise in UK base rates from their record low of 0.5 per cent could come sooner than financial markets had been expecting. This has fuelled speculation that a rise could come by the end of 2014. Base rates have been at 0.5 per cent since March 2009.

Fraser of Allander is now forecasting growth in Scottish gross domestic product of 2.5 per cent in 2014, up from the 2.3 per cent rate which it projected in March, and expansion of 2.2 per cent in 2015, down from the 2.3 per cent pace predicted in the spring.

While the think tank's central projection is for growth in 2016 of 2.4 per cent, it believes expansion in that year could be as low as 1.3 per cent.

Fraser of Allander believes the latest official data has revealed a recovery in the Scottish and UK labour markets "which is almost unprecedented".

It notes the International Labour Organisation measure of unemployment in Scotland now stands at 6.6 per cent, the same as that for the UK as a whole.

However, citing a belief that there continues to be plenty of slack for growth in the Scottish labour market in spite of the headline figures, the think tank says: "It is clear that growth in employment is still being sustained by the growth of part-time work and self employment. Moreover, there are still a large number of part-time workers who are seeking and cannot find a full-time job."

Asked about Fraser of Allander's view on the independence issue, ahead of the September 18 referendum, Mr Ashcroft replied: "We are being scrupulously neutral on this, as we should be."

He added: "There is a view that investment might be being held back by uncertainty surrounding the referendum, although the contrary view is Scotland has been doing very well in terms of attracting investment since last year."

PwC's Mr Brewer said: "It is quite easy for investment to be disturbed and delayed by that kind of uncertainty. There is certainly some evidence of that happening. Once we get past the referendum, business will be looking for certainty.

"I think that certainty will be a positive opener of decisions to invest."

Asked about specific evidence that the referendum was affecting investment decisions, Mr Brewer said: "It is a very subtle thing. You can't prove a negative."

While noting that "very few" businesses were saying that they were not investing as a result of uncertainty, he added: "It is one of the many things in the mix of investment decisions, as well as demand [and] tax rates."