Interest rate expected to stay on hold until 2013

Interest rates may stay at current record lows well into 2013 as government cutbacks will slow the pace of the recovery says Peter Spencer, chief economist of the highly respected Ernst & Young ITEM club.

Spencer believes inflation will remain above the 2% target over the next 18 months as high energy prices and next year's VAT increase push up prices, but will fall 'well below' 2% after that.

'To prevent CPI inflation moving below 1% it will be necessary to keep the Bank base rate low at 0.5% for much longer than the Office for Budget Responsibility and the markets have anticipated,' Spencer said.

The ITEM forecast suggests that the base rate, set by the Bank of England’s Monetary Policy Committee, will remain on hold until the end of 2013, although Spencer said his forecast is dependent on the assumption that the impending spending cuts actually come through.

Others though have been suggesting that the first increase in rates will be much sooner, especially after the much higher than expected 1.1% leap in UK GDP on Friday.

While that led many to assume the Bank of England needs to withdraw some stimulus from the economy, Spencer believes cutbacks mean UK economic growth will be slow over the next two years. 

He expects UK growth will struggle to reach 1% this year but said it will gradually pick up pace in the following years to give the UK a high-quality recovery based on trade and investment.