Inflation may force interest rate rise to 8%

Published on Sunday 22 August 2010 15:03

Interest rates could rise to 8 per cent by 2012 if inflation gets out of control, a think tank warned yesterday.

Andrew Lilico, chief economist at the Policy Exchange, said the Bank of England may be forced to dramatically hike the base rate due to rapidly rising inflation.

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 said 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."

The Bank of England has pumped 200 billion into the economy through quantitative easing.

But Dr Lilico warned that this policy had quadrupled the money base, and he claimed 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 said: "Since interest rate rises will raise mortgage rates, the initial effect will be even more inflation."

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

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

But he added that if households did not take the opportunity to reduce their debts between now 2012, interest rate hikes to 8 per cent would lead to mass mortgage defaults.

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