Interest rates could hit eight per cent by 2012, according to the chief economist at Policy Exchange.

This controversial claim goes against the Ernst & Young ITEM Club report last month, which predicted that interest rates would remain at 0.5 per cent until the start of 2014.

Andrew Lilico, chief economist at Policy Exchange claims that interest rates could have to increase to eight per cent to combat the high inflation that will couple the boom he is predicting.

According to Lilico this will all happen in the next 18 months to two years, and after a much talked about ‘double-dip’ recession.

Commenting in his paper ‘Five politically relevant things about where we are in the economy’, he said: “Once the economy starts growing properly again, more normal times will be restored, the banks will cease to fear imminent collapse, lending will expand and the money supply will grow rapidly.

“There will then be ‘too much money chasing too few goods’ and as well as rapid growth in late 2011 and into early 2012, we will see rapidly rising inflation.”

And, he states, rising inflation means that interest rate increases are inevitable. In the early 1990s RPI inflation was above 10 per cent following rapid interest rate rises. And Lilico expects the next spurt of growth in the UK economy to match this, meaning CPI inflation of around six per cent.

And to keep inflation from increasing further, this means that interest rates will have to rise to near eight per cent, Lilico claims.

And, interest rate rises of this extent could mean yet another recession in 2013/14. However, the gloomy report also notes that the UK may not be able to tolerate interest rates of eight per cent because it could lead to mass defaults on mortgages.

Lilico’s views have been called extreme, but they also demonstrate the fragile state of the economy and the mixed views that economists are taking on the UK’s recovery.

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