Interest rates could hit 8% by 2012

8 per cent road sign

Interest rates could hit 8% in just two years’ time, as the Bank of England will be forced to employ rate hikes in order to tame rising inflation, according to Policy Exchange, an influential think tank.

Its chief economist, Andrew Lilico said that the £200 billion of cash pumped into the economy during the height of the financial crisis – known as quantitative easing – would lead to a “huge expansion of money supply which will lead to inflation”.

This, in turn, would put pressure on the Bank of England to raise rates to as high as 8% - levels not seen since the last recession of the early 1990s.

While higher interest rates could bring healthier offerings in the savings sector, it is likely to spell disaster for the country’s borrowers – many of who are already stretched to the limit after the last recession. 

Homeowners are first to the chopping block. According to financial data provider Moneyfacts, a base rate of 8% could result in average mortgage costs of up to 14% after lenders have built in their own profit margins.

These margins would be even greater than they are now (mortgage rates currently average 4% against a current base rate of 0.5%) to offset the added risk of homeowners defaulting on their loans. 

Priced at 14% a £200,000 repayment mortgage taken over 25 years would cost just under £1,000 extra each month than at today’s typical level of 4%.

A hike of that magnitude to the monthly budget would be simply impossible for most homeowners to absorb, according to Darren Cook, spokesperson for Moneyfacts.

“We don’t think the Bank of England will put interest rates up to 8% as it knows that the country was just fall over. Even if rates returned to more normal levels of 4% or 5%, many homeowners would struggle – not everyone has used the surplus cash from sustained rates of 0.5% to pay off their mortgages.” 

Only one of the nine members of the Monetary Policy Committee, which decides on movements in the base rate, voted for a hike of up to 0.75% August.

But inflation is already higher than it should be. The consumer prices index measure of inflation stood at 3.1% in July against the government target of 2%.