Interest rates unchanged ‘until 2014'

The current Bank Base Rate of 0.5% will begin to look like the 'new normal' with hikes unlikely until 2014, according to a leading economic forecaster.

The Ernst & Young Item Club said rates would need to be kept low to counter-balance the Government's spending cuts.

Professor Peter Spencer, ITEM's chief economic adviser, added the Bank may even have to restart its £200bn quantitative easing programme.

He said: "Monetary policy [will have to] remain very loose in order to offset the dampening effects of fiscal policy. Further asset purchases cannot be ruled out if there are signs that the recovery is relapsing."

ITEM's interest rate forecast is in contrast to that of the Office for Budget Responsibility (OBR) which says rates will rise next year and reach 3% by 2014.

Assuming rates stay at 0.5%, ITEM expects the economy to grow roughly in line with OBR forecasts at 2.2% next year and just below 3% for the following three years.

Pressure for an early rate rise mounted last week after ONS data showed the economy grew at 1.1% in the three months to June, almost double forecasts.

However, Spencer said:

"The GDP figures don't change the general picture of a patchy, sporadic recovery, which picks up very gradually."

Low interest rates will be hard to sustain, he warned, as inflation will remain above target until the end of 2011.

"It is actually a very tricky situation for the Bank because VAT increases will keep inflation well above target until the end of next year, with all sorts of people saying that rates should be raised," he said.

Despite low interest rates, ITEM does not expect house prices to continue rising.

"With unemployment high and confidence fragile, particularly in light of the impending tax increases and public spending cuts, the mini-housing market recovery of the past year looks increasingly unsustainable," the report said.