Where will interest rates be in 2012? 31 August 2010
Kara Gammell (about the author)

Home owners must have been scared out of their minds on hearing the warning from a leading economist this week that the Bank of England will be forced to raise the cost of borrowing to 8pc by 2012.

But that is just the start. If Bank Rate hits 8pc, mortgage rates could be as high as 14pc once lenders have added their profit margins. Such double-digit rates would leave tens of thousands of home owners unable to afford their mortgage repayments.

Andrew Lilico, chief economist at the Policy Exchange think tank, argued that the £200bn pumped into the economy by the Bank of England during the financial crisis would lead to "a huge expansion in the money supply, which will lead to inflation".

To keep inflation in check – even at 10pc – the Bank of England would have little option but to raise Bank Rate to 8pc, he warned.

"There is a risk that … the economy will not be able to tolerate 8pc interest rates without the mass defaulting on mortgages that we are trying to avoid," he said.

Steven Jackson of beatmydebt.com warned that any rse in interest rates will have a devastating affect on many people. "There are a large number of homeowners who are currently struggling to make ends meet even with interest rates as low as they are. If and when we see rises, there will be increasing numbers who simply cannot afford to pay their mortgage" he said.

Other economists rubbish forecast

Mr Lilico forecast a Bank Rate of 1.5pc in 2011, jumping to 8pc in just 12 months. Mr Lilico did not want to speculate further ahead. "There will be great volatility after 2012 and there is just too much uncertainty to even try to give a forecast."

The question is whether Mr Lilico's pessimism is shared. We canvassed the views of economists, analysts and housing experts to gather a consensus on how high interest rates will go.

We can offer some Bank Holiday cheer: no one came close to forecasting the 8pc predicted by Mr Lilico.

Jamie Dannhauser of Lombard Street Research said there was no way the Bank of England would allow the money supply to expand at the rate necessary to bring a return to Nineties-style inflation. "It's a complete load of rubbish," he said. "It would involve the Bank being completely asleep at the wheel."

John Hawksworth, the chief economist at accountancy firm PricewaterhouseCoopers, said it was extremely unlikely that Bank Rate would rise to anywhere approaching 8pc. "We think Bank Rate will stay at 0.5pc for the rest of 2010, starting to rise slowly to 3.5pc by the end of 2012," he said.

Inflation unlikely to spiral out of control

Andrew Pipe of Lloyds Banking Group said inflation would have to go through the roof for interest rates to be raised to 8pc and he did not believe that inflation would spiral out of control.

"Even though the recession has destroyed some of the economy's capacity, it is highly likely that there is still a significant amount of spare capacity and this will tend to push down inflation once the temporary boosting factors such as the VAT increase wash out. As a result, we see base rates rising very slowly during the recovery," he said.

While Mr Lilico's views are considered extreme, the legacy of the credit crunch lingers and his view cannot be ruled out. Philip Shaw of Investec Securities said: "One lesson from the credit crisis has been 'never say never', but it seems unlikely that rates will reach as high as 8pc over the next two years. We think they will start to rise early next year, but only gradually."

The certainty that all home owners face is that interest rates will go up once the economic recovery is on a firmer footing.

Prepare for rate rises

Steven Jackson said that people should start preparing for rate rises. "One thing that is for sure is that rates will increase. People need to get ready for that now by getting their personal spending under control and giving themselves more financial flexibility. Saving some money each month to keep aside for a rainy day has never been more important" he advised.

Borrowers will be wondering how much longer to wait before they opt for a fixed-rate mortgage. The dilemma has been heightened with lenders reducing rates recently – the average two-year fixed rate is now 3.24pc.

Melanie Bien, from mortgage broker Private Finance, said those sitting on cheap standard variable rates (SVRs) should be vigilant. "If you are on one of the cheaper SVRs of 3.5pc or less, enjoy it, but be prepared to act when rates start to rise," she said. "If you are on a more expensive SVR it might be worth remortgaging now. There are some competitive fixes starting at less than 4pc."

David Hollingworth of London & Country Mortgages said the high forecast served a good purpose in focusing people's minds on how they would cope when rates rose. "It is important that borrowers prepare and in some cases that will mean a fixed rate. There are certainly some decent fixed rates available."