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August 23, 2010    

Sharp interest rate rises on the way, predicts think tank

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by Kay Murchie
”Sharp

Influential think tank, the Policy Exchange, has warned interest rates may be hiked to 8% by 2012, in order to combat stubbornly high inflation.

Interest rates remain at the 300-year record low of 0.5% - where they have been since March 2009 - in order to boost the economy and bring it out of recession.

However, over recent months, the CPI inflation rate has risen and currently stands at 3.1% – the eighth consecutive month that inflation has been above the 2% target.

The CPI inflation rate is a benchmark for the Bank of England’s Monetary Policy Committee (MPC) but Mervyn King, the Bank’s Governor, has already dismissed fears that higher inflation would demand a significant rise in interest rates in the months ahead.

The Policy Exchange‘s chief economist, Dr Andrew Lilico, believes a double-dip recession is possible, which would then be followed by a boom - fuelled by huge monetary growth.

Together with massive Government spending cuts, this could result in the fastest economic growth rate since the late 1980s, according to Dr Lilico.

Dr Lilico says 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.

“Once inflation rises, interest rates will rise rapidly as well. Since interest rate rises will raise mortgage rates, the initial effect will be even more inflation,” he added.

He expects inflation to rise to around the 10% mark - a similar level seen in the early 1990s - but five times higher than the current target.

Meanwhile, presenting the latest Quarterly Inflation Report, Mr King predicted that inflation will fall below its target of 2% by the end of 2011.

The recent decision to hike VAT to 20% next year by the coalition Government will undoubtedly keep inflation higher, said the Bank.

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