Interest rate rise 'could hit Scottish economic recovery'

House prices in London are rising at a far faster rate than elsewhere in the UK

Raising interest rates to counter soaring London house prices could put Scotland's economic recovery at risk, according to an analysis.

The Bank of England signalled last week that interest rates may rise this year.

It came amid concern London's property market is overheating, with prices increasing far faster than elsewhere.

But the Fraser of Allander Institute said it would be "inappropriate" to dampen the rest of the UK's recovery for a "local issue centred on London".

In its final economic commentary before September's independence referendum, the institute said the Scottish economy was now enjoying a strong recovery, with employment and productivity up and strong growth forecast in production and manufacturing.

The institute, which is based at the University of Strathclyde, revised its forecast for Scottish GDP growth in 2014 to 2.5%, up from its March forecast of 2.3%.

It said the rise in its 2014 forecast was a result of the generally better than expected improvement in performance, optimism in business surveys and an improved outlook, especially for investment.

But the economists also identified a number of risks which they said threatened the sustainability of the recovery, and which resulted in the institute lowering its 2015 forecast marginally from 2.3% to 2.2%.

These included:

• The boom in London house prices

• A continuing unbalanced recovery (between household spend, business investment and export growth)

• Falling UK real wages

• Deflation in the eurozone

Of the four risks, the institute said it was most concerned about the impact of the London property market.

The Office for National Statistics said on Tuesday that property prices in London are rising at an annual rate of 18.7% compared with 9.9% across the UK as a whole. In Scotland, the figure was 4.8%.

The Bank of England's governor, Mark Carney, has signalled that he may raise interest rates later this year from their current record low of 0.5% if it was thought necessary to cool the housing market.

Mortgage repayments

There are concerns that when interest rates rise, many homeowners could struggle with their mortgage repayments, although Mr Carney stressed any increases would be "small and gradual".

Brian Ashcroft, Emeritus Professor of Economics at the University of Strathclyde, said: "The Grangemouth dispute which shut down the refinery plant last October lowered Scottish GDP growth in the final quarter of last year and masked the strength of the recovery, while the recovery in the Scottish and UK labour markets is almost unprecedented.

"However, we are concerned that the risks to the recovery have widened and deepened. 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.

"But 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 Fraser of Allander Institute said its 2016 GDP forecast of growth of 2.4% reflected a "reasonably optimistic view" that the risks would be overcome.

But if they are not, it said growth could be as low as 1% in 2016.

One bright spot for the Scottish economy was the evidence that real Scottish wage growth appeared to have become positive in 2013 while UK real wage growth has remained negative for the past three years.

Prof Ashcroft added: "This may be due to a faster growth in labour productivity in Scotland. If so, the prospects for Scottish household spending might be a little rosier than in the UK."