Interest rates could hit 8%, says economist

Andrew Lilico, chief economist at the Policy Exchange, says the Bank of England may be forced to dramatically hike the base rate if inflation rises dramatically (see the The Remortgage Guide and Top Savings guides).

Dr Lilico thinks the UK is likely to suffer from a double dip recession, followed by a boom, driven by huge monetary growth, leading to the strongest economic growth since the 1980s.

He says in a research note: "Once the economy gets growing sustainably, there will be a huge expansion in the money supply, which will lead to inflation."

However, other economists are not forecasting such a dramatic rise.

Most experts do not expect the Bank to raise interest rates until next year at the earliest, and any increases are expected to be gradual.

'Too much money'

The Bank of England has pumped £200 billion into the economy through quantitative easing, which means printing new money.

But Dr Lilico warns this policy had quadrupled the money base, and he claims that once the economy starts growing again, lending will expand and there will be "too much money chasing too few goods".

This will trigger a rise in inflation, and once inflation starts to rise, interest rates will have to rise too.

He adds: "Since interest rate rises will raise mortgage rates, the initial effect will be even more inflation."

'10% inflation'

He expects inflation to rise to around 10%, similar to levels seen in the early 1990s and five times higher than the Government's 2% target.

The steep rise in inflation and interest rates could also threaten the economic recovery and cause another recession in 2013 or 2014, he says.

If households do not reduce their debts between now and 2012, interest rate hikes to 8% would lead to mass mortgage defaults, he adds..

Bank of England Governor Mervyn King said last week that rate-setters had been "surprised" at the recent strength of inflation.

He said: "How fast and how far inflation will fall are both difficult to judge, with substantial risks in both directions."

Further reading/Key links

Plan for problems: Redundancy Help, Mortgage Arrears Take action: Debt Problems Get what you're entitled to: Benefits Check UpMortgage cost-cutting guides: The Remortgage Guide, First-time Mortgage Guide, Cheap Mortgage Finding, Ditch My Fix?