Britain may have to choose between 20% inflation and a massive level of mortgage defaults, says Andrew Lilico, chief economist at Policy Exchange.
The think tank also says Britain is heading for a double dip re-cession. Although Lilico does not believe the Bank of England will raise interest rates above 2% before late next year, he does think they will hit 8% by 2012.
And he says inflation will rise rapidly at the same time too.
Lilico says: “Since interest rate rises will increase mortgage rates, the initial effect will be even more inflation. In the early 1990s, Retail Prices Index inflation went above 10% off the back of rapid interest rate rises.
“I expect a similar level of inflation in 2012 – that would imply Consumer Price Index inflation exceeding 6% com-pared with its recent peak of 5.2% in September 2008. So what I’m proposing is only a slightly larger overshoot of inflation than that only two years ago.”
He says that 10% inflation is inevitable but the only way to stop inflation being this high long term is to raise interest rates to 8%.
If households do not reduce their debts, he says the rise could result in widespread mortgage defaults. Lilico adds: “If that is the case, interest rates may have to be kept lower for an extra nine months and the consequence will be infla-tion peaking at 20% rather than 10%, as in the 1970s, when there were two years of inflation above 20%.”
According to the Council of Mortgage Lenders Policy Exchange is at the extreme end of the spectrum.
But Lilico says his claims are not extravagant and that the City has lost its sense of historical pers-pective. His most optimistic predic-tion sees another recession in 2013 and 2014.