Interest rates 'may hit 8%' by 2012 says think tank

Bank of England reflected in a shop window Interest rates remain at a record low of 0.5% but the Policy Exchange expects some very sharp rises

An influential think tank has warned that interest rates may have to rise to 8% to combat rampant inflation.

The warning comes from the Policy Exchange, whose chief economist, Andrew Lilico, argues an economic recovery will unleash a wave of money.

Doctor Lilico believes a double-dip recession is likely, which would then be followed by a boom.

He argues that the US and UK monetary authorities will respond to this by printing more money.

Coupling that, he says, with the planned deep government spending cuts, would lead to the fastest economic growth rate since the late 1980s.

Doctor 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."

The Bank has already pumped £200bn into the economy under quantitative easing to help stimulate demand.

'Rise rapidly'

He says that policy of the Bank of England has quadrupled the monetary base and once the economy starts growing properly again, lending will expand and there will then be "too much money chasing too few goods".

Doctor Lilico believes that "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 expects inflation to hit a similar level to that of the early 1990s, in the region of 10%.

Base rates have been at record lows of 0.5% for the past 16 months.

At the last meeting of the Bank of England's Monetary Policy Committee (MPC), only one member suggested a modest rise in rates to 0.75%.

The Bank has said that it is not overly concerned about price rises, even though they are rising at more than 3% a year, above the 2% target.

The Bank's governor, Mervyn King said he had been "surprised" by the recent strength of inflation, but added the factors pushing prices higher were temporary.

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