'Interest rates set to stay at record low to balance government cuts'

Published on Sunday 25 July 2010 17:03

A LEADING economic forecaster today said UK interest rates will have to stay at their record low of 0.5 per cent for much longer than currently expected.

The Ernst & Young Item Club, which bases its forecasts on the Treasury's model of the economy, said the Bank of England's base rate will remain on hold until 2014 in order to balance government austerity measures.

The forecast contrasts with the view in the City and at the Office for Budget Responsibility that interest rates will start to rise next year.

High energy prices and the increase in VAT will keep inflation above target over the next 18 months, but E&Y believes it will move below 2 per cent as these effects wear off and spare capacity bears down on pricing decisions.

"A base rate of 0.5 per cent will begin to look like the new normal," Ernst & Young Item Club's chief economic adviser Peter Spencer said.

The report said fiscal tightening by the coalition government will slow economic growth in the next two years but should not choke off the recovery.

It added that it expected more sustainable high-quality growth from 2013 because it will be led by business investment and exports, not public spending.

Mr Spencer added: "The bulk of the additional tightening is set to come in the second half of the parliamentary term, when we believe that the recovery will be firmly entrenched."