Interest rates could remain low for up to four years as inflation fears create tension at the Bank of England.

Ernst & Young’s ITEM club report today warns that rates will have to stay on hold until the start of 2014 if the economy is to be given a chance to recover, despite the economic outlook advancing more than expected last month.

Today ITEM has said that inflation fears are mounting at the Bank of England, especially with VAT due to rise to 20 per cent in January. The report says that the MPC committee are likely to face tough decisions in order to counteract the effects or inflation and the base rate low of 0.5 per cent is likely to stick.

ITEM is forecasting growth of 2.2pc next year, 2.8pc in 2012 and 2.9pc in 2013 but only on the assumption that interest rates are held at 0.5pc until early 2014. The Office for Budget Responsibility – the Treasury’s independent forecaster – is predicting roughly the same pace of growth but with rates rising to 3pc by 2014.

Peter Spencer, chairman of the Ernst & Young ITEM Club said: “A base rate of 0.5% will begin to look like the new normal.

“The problem is that on the surface the economy looks to be inflating but once you delve deeper, you can see that the situation is very disinflationary.

“From January 2012, inflation will drop below target. After one year of higher prices, the VAT rise will take demand out of the economy . . . The tensions among the MPC in particular are going to be excruciating over this period.”

Although supportive of Treasury plans to tackle the UK’s deficit through tax rises and spending cuts, Mr Spencer warned “monetary policy will have to remain very loose in order to offset the dampening effects of fiscal policy”.

He added that the Bank may have to consider more quantitative easing, on top of the £200bn asset purchases already completed.

© Fair Investment Company Ltd