The International Monetary Fund (IMF) has warned the government that accelerating house prices and low productivity pose the greatest threat to the UK's economic recovery.

The IMF has warned the Bank of England against raising interest rates too soon

It said rising property values could leave households more vulnerable to income and interest rate shocks.

It also called on the Bank of England to enact policy measures "early and gradually" to avoid a housing bubble.

In April, the IMF said the UK economy would grow by 2.9% in 2014.

The Fund's annual health check of the UK economy found it has "rebounded strongly and growth is becoming more balanced" adding economic growth would "remain strong this year."

It is a significant turnaround from last year when the IMF's chief economist Oliver Blanchard appeared to have a public falling out with the chancellor after he criticised the government's austerity policies.

This year IMF managing director Christine Lagarde admitted the Fund "got it wrong" in its assessment adding that while the UK's economic recovery began with consumer spending, it was now rebalancing towards an "investment-led recovery".

The chancellor said the IMF was "right to warn the government that risks still remain" to the UK's economic recovery.

Ms Lagarde called on financial regulators to consider imposing limits on the number of low-deposit mortgages a bank or building society can advance to borrowers, highlighting fears that some people may be at risk of overstretching their finances.

The IMF report said: "House price inflation is particularly high in London, and is becoming more widespread. So far, there are few of the typical signs of a credit-led bubble.

"Nonetheless, a steady increase in the size of new mortgages compared with borrower incomes suggests that households are gradually becoming more vulnerable to income and interest rate shocks."

It added: "Macroprudential policies should be the first line of defence against financial risks from the housing market."

It said that raising mortgage lenders' capital requirements "would build additional buffers against increased exposures to the housing sector".

Help to Buy

The Bank of England's Financial Policy Committee (FPC) is due to meet later in June and could announce measures to control mortgage lending.

In May, 25% taxpayer-backed Lloyds Banking Group said it would limit its mortgage lending to four times a borrower's income on loans above £500,000.

On Tuesday, Royal Bank of Scotland - which remains 80% taxpayer-owned - said it would also restrict the amount it advanced to mortgage borrowers.

The IMF added the government should consider modifying or even pulling the plug on its flagship mortgage guarantee scheme - known as Help to Buy 2 - if house prices showed signs of overheating.

Recent figures from the Treasury showed 7,000 homes were bought through the Help to Buy scheme between its launch in October and March.

That amounted to just over £1bn of mortgages since the scheme's launch, involving just £153m of government guarantees.

Howard Archer, chief UK and European economist at IHS Global Insight, has previously warned the risk of a house price bubble developing across the UK is "very real".

Earlier the chancellor told BBC Radio 4's Today programme: "We need to be alert to the build-up of debt in the housing market, we need to be alert when we see house prices rising."

"We have created - this government, me as chancellor - the mechanism to deal with that,

"We have given the Bank of England the tools to do the job and they should not hesitate to use those tools if they see these developments turning into a risk for the British economy."

Interest rates

While the IMF praised the Bank of England's policy of forward guidance, it warned that if economic growth expanded more than current forecasts suggest, interest rates might have to rise more quickly in order to control inflation.

Bank governor Mark Carney has previously stated that he envisages interest rates rising from their historic low of 0.5% incrementally and not before the middle of 2015.

The IMF also echoed the Bank of England's own concerns about productivity levels, saying that despite evidence of the UK economic recovery strengthening, productivity growth remained low.

It added "Accelerating productivity growth would spur investment and output, while allowing real wage increases without triggering inflation. If productivity continues to be flat, however, growth will eventually stall."

Productivity reflects the amount and value of the goods and services produced by an employee of a company. But productivity depends partly on business investment.

In February, the Bank of England said there was still a significant amount of "slack" in the economy, meaning that it was not growing to its full potential because of underinvestment.

It estimated the amount of slack in the economy was equivalent to about 1% to 1.5% of gross domestic product (GDP).

Earlier, the Office of National Statistics showed the UK's trade deficit with the rest of the world - the different between the value of the goods and services the country exports and imports - widened in April to £2.5bn.

The UK's goods deficit widened in April to £9.6bn from £8.3bn in March and £8.5bn a year earlier, denting the chancellor's hopes of boosting exports in an effort to rebalance the economy.

Source: BBC