“Interest rates rise to 8% in two years”- Never

Yesterday I read this article in the Telegraph, of which I provide a summary:

“Interest rates may rise to 8% within two years to choke off soaring inflation, according to radical new research by the influential Policy Exchange think tank.

The rise could happen as the recovery beds in and Government measures to stave off a recession lead to an explosion in the money supply.

Mr Lilico, Chief Executive of the think tank also warned of a return to “boom and bust”, as ballooning inflation threatens to tip the economy back in to recession in 2013 or 2014.

“Given the constraints of late 2008 and the absurdities of subsequent fiscal, finance and regulatory policy, if we can get away with a recession of only 6.6pc, deflation of only 2pc and inflation of only 10pc for one year, [Bank of England Governor] Mervyn King will deserve a medal,” Mr Lilico said.

A brief double dip recession early next year is likely, he said, but it “would be quite compatible with a boom thereafter”.

That boom would quickly run out of control, as the £200bn of “money printing” by the Bank during the crisis would lead to “a huge expansion in the money supply, which will lead to inflation”.

He estimates that the Retail Prices Index (RPI), the inflation measure favoured in wage settlements and against which annual rises in train fares are priced, would rise “above 10pc”.

The Consumer Prices Index (CPI), the inflation measure that the Bank is responsible for keeping at around 2pc, will top 6pc, Mr Lilico reckons.

This week, official data from the Office for National Statistics is expected to confirm that the economy grew 1.1pc in the second quarter of the year – reinforcing hopes that the recovery is strong enough to withstand the Coalition’s planned spending cuts.

To control inflation, “interest rates will rise rapidly as well”, Mr Lilico says. “To keep [RPI] inflation down to only 10pc for one year, the economy will have to be able to tolerate interest rates of perhaps 8pc.”

High interest rates, however, could prove too much for households, which are currently benefiting from historically low average mortgage rates of 4pc.

Mr Lilico added: “There is a risk that… the economy will not be able to tolerate 8pc interest rates without the mass defaulting on mortgages that we are trying to avoid. If that is the case, then interest rates may have to be kept lower for an additional nine months and the consequence will be inflation peaking at 20pc rather than 10pc, as in the 1970s.

The consequence of interest rate rises will be another recession in 2013 or 2014,” he said.

The concluding remarks of the Telegraph showed disagreement with this report and we agree. Even though since 1997 the primary objective of the MPC has been to control inflation and it is considered a separate entity to the Government, there is no chance just to control inflation interest rates will be put up this amount. The MPC and the coalition government has learnt a hard, tough lesson through the recession and are not about to stop the nation recovering solely to control  inflationary pressure.

A rise of this magnitude would result in major default on variable mortgages; not only from homeowners but also investors, mortgage costs for certain properties will increase 4 or 5 fold.  The result would be loss of confidence, major repossessions, reduction in disposable incomes and therefore a significant impact on consumer spending. This would significantly knock the economy into shock and we could return to the black days of the early nineties or worse. I do not think there is anything to worry about, worst situation in my opinion is interest rates rising two to three percent, like in the early noughties, this will help control inflation, Understandably the rate rise would mean less surplus for landlords on variable rate mortgages, but homeowners on the brink may face selling or losing their home; end result a boost for rental markets, and potential cheap quick sales available for investors.

Overall interest rates of 8%, not in the next decade!

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Reply to original article by Philip Aldrick in The Telegraph on 21st August 2010

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