8% interest rates could create double dip recession, says Policy Exchange

23 August 2010 | By Samuel Dale

Britain is heading for a double dip recession, 8% interest rates and 10% inflation claims Andrew Lilico, chief economist at Policy Exchange.

Lilico does not believe the Bank of England will raise interest rates above 2% before late 2011 but they could hit 8% in the coming years.

And he says inflation and interest rates will rise rapidly at the same time too.

He says: “Since interest rate rises will raise mortgage rates, the initial effect will be even more inflation. In the early 1990s RPI inflation went above 10% off the back of rapid interest rate rises.

“I expect a similar level of inflation in 2012 - that would imply CPI inflation exceeding 6%, vs its recent peak of 5.2% in September 2008 — thus what I’m proposing is only a slightly larger overshoot of inflation than that only two years ago. If we see no more than one year of inflation of above 10%, and no year of deflation of more than 5%, I shall consider the Bank of England’s policy to have been a resounding and surprising success.

“On the other hand, to keep inflation down to only 10% for one year, the economy will have to be able to tolerate interest rates of perhaps 8% - note that interest rates were 7.5% in 1998, so the rates I am suggesting were very normal before the past ten years.

“But there is a risk that, between now and 2012, households will not take the opportunity to reduce their debts by enough, and so the economy will not be able to tolerate 8% 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 20% rather than 10%, as in the 1970s, when there were two years of inflation above 20%.

Lilico says his claims are not extravagant and that the City has lost its sense of historical perspective.

He says that being optimistic he sees the consequence of interest rate rises as another recession in 2013 or 2014.

Readers' comments (13)

Anonymous | 23 Aug 2010 1:01 pm
Just love the cheerful news on a Monday afternoon!!!
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Danny Lovey | 23 Aug 2010 1:04 pm
What a complete lot of tosh!!!

The banks have around £800 billion to refinance including paying back what they owe to the BOE - The QE programme was a one off that can be(and should) be reversed at some stage.

We are in for a tough time fiscally and raising rates would be completely counter productive to head off 'imported' inflation that the BOE can do nothing about.

To suggest that inflation would be created by too much money chasing to few goods is a pipe dream over the next 2-5 years. The interest rate tool has always been a blunt weapon and would damage growth prospects for industry.

The 'think tank' should either stop thinking or just give up and get a life!
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Chris Simpson | 23 Aug 2010 1:13 pm
Rubbish!
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Anonymous | 23 Aug 2010 1:28 pm
Scremongering into getting borrowers to panic into entering fixed rate contracts.
I would not be at all surprised if Mr Lilico has a vested interest in publishing such nonsense.
Interest rates will remain low for some time, maybe for 2 years in order to keep the economy ticking along.Rates to the order of 8% would be disastrous for the economy and WILL NOT HAPPEN.
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David | 23 Aug 2010 1:29 pm
Anybody thinking of inviting this guy to their christmas party?
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Tom IFA | 23 Aug 2010 1:57 pm
Andrew will property prices accelerate at he same rate?
Is our old friend/ enemy inflation once more to the rescue or ruin of our economy?
C'mon give ius the whole scenario.
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John Lacy | 23 Aug 2010 2:33 pm
Speculation, guess work and doom and gloom don't really help.
When are the frogs and locusts due to arrive?
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Anonymous | 23 Aug 2010 3:34 pm
So who does he REALLY work for?
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Dan McGeehan | 23 Aug 2010 4:08 pm
Its one person's point of view and although he may be respected in the field of economics he is in the minority with respect to his prediction. I sometimes get the feeling that some economists come out with left field predictions simply to gain some exposure. His comments that the majority of the population is not taking advantage of paying down debt shows his lack of understanding of how the economy is actually impacting on everyday life and people's pocket. This is main reason to me that with the fragile economy we currently have that we could not sustain high interest rates in the short term.
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Anonymous | 23 Aug 2010 10:22 pm
I wonder if this man willing to put money where his mouth is? - I bet not.

The headline should have been house prices to fall 8% by 2012.

Some people will say anything to get publicity - but who knows, maybe it may happen? - a jump to 8% in 2 years though??
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