My thoughts on the Policy Exchange forecast of Bank Rate at 8% in 2012

Posted on 26 August 2010 by Ray Boulger

5 comment(s)

No doubt the reason Andrew Lilico, Chief Economist of Policy Exchange, which calls itself a think tank, chose to issue his paper forecasting Bank Rate would rise to 8% in 2012 this week is that in the August silly season when real political news is thin on the ground it is much easier to grab some headlines by publishing an outrageous forecast than when senior politicians are around to rubbish such forecasts. Policy Exchange must be desperate for some publicity!

Only last month Policy Exchange published a report questioning many of the assumptions in a book entitled Spirit Level. I have no idea whether the criticism was justified but the interesting point is that its report was entitled “Beware False Prophets,” a title which could more appropriately have been given to the report it published this week.

You will all remember that Gordon Brown abolished boom and bust (ahem!). What Policy Exchange is forecasting for the next 4 years is much worse than boom and bust – roller coaster would be a more appropriate term.

Mr Lilico forecasts a double dip next year and claims we have had several double dips since the mid 1950s, but he is making up the definition of double dip to suit his purpose. The conventional definition of a recession is 2 consecutive quarters of negative GDP but all the double dip examples Mr Lilico gives involve only one quarter of negative growth following the initial dip and subsequent recovery. Other economists take the view that 2 more quarters of negative growth are required for there to be a double dip.

He forecasts Bank Rate will rise to 2% by the end of next year and then shoot up to 8% in the following year on the back of a rapid increase in inflation caused by the Bank of England massively increasing its quantitative easing programme next year to counteract the double dip recession he forecasts next year.

If Bank Rate was to increase by 6 percentage points, i.e. a 300% increase, from 2% to 8% in the space of only 12 months property prices, both residential and commercial, would collapse on the back of the inevitable massive hike in mortgage rates. Arrears and repossessions would escalate rapidly and bank balance sheets would again come under huge pressure as a result of the massive write offs they would have to provide for on their property loans. Chances are the some of the weaker banks would again have to be rescued by the Government, assuming it had the appetite to do so and could afford to.

The Bank of England of courses realises this would be the consequence of increasing interest rates by so much so quickly and so it will not happen.

Mr Lilico is getting his excuses in early for being wrong – the paper says:

I could well be wrong in all kinds of ways:

  • we might not have a double dip, so they may raise interest rates materially in the second quarter of 2011 instead of holding them below 2% throughout the year as I expect.
  • we may have a double dip and they might lose control of deflation, with prices falling dramatically through 2011 and 2012 instead of rising.
  • inflation might go much higher than the sorts of numbers I’ve suggested.

There is no reference in this paper to economic events outside the UK. Mr Lilico appears to think that the UK operates in a vacuum, whereas more bad economic news this week from the USA has pushed gilt yields and swap rates to new all time lows, with 5 year swaps now down to a new all time low of 2.03%.

If Mr Lilico is prepared to put his money where his mouth and is proved right he could make a fortune as his views are so extreme. The logical approach for someone with his expectation of how the economy will play out would be to sell any property owned, rent one’s home and invest the resulting equity in out of the money gilt put options, which are a low priced highly geared investment giving the right, but not the obligation, to sell gilts in the future at around today’s price.

Although it might be considered that the high inflation he forecasts would be good for property prices this is only true in the long term. In the short term the huge hike in interest rates to try to control the jump in inflation would be a much more important influence on property prices. Only after a few years of high inflation when borrowers had adjusted to the higher interest rates could property prices be expected to start rising again, but it would be from a significantly lower base. Even that assumes that the banks would by then have repaired their balance sheets sufficiently from the very sizable new bad and doubtful debts they would have incurred to again become active in the mortgage lending market.

Categories: Property market, Bank of England, Mortgages, House and home, Interest rates


The interest rate appears irrelevant given its wholesale lack of relationship with (e.g.) mortgage rates. I donwonder why it is you can't get a 20-year fixed rate in the UK at European levels. The Brits are uneducated suckers. Oh, and Mr Boulger: Please do a piece dismantling the absurdity of the "average" house price. When a two-bedroom flat in the north east costs almost double the alleged "average" I have to declare the latter redundant. Possibly you would do better to look at the median price - and indeed outside London. also - perhaps look more closely at the inter-relationship between value, affordability, real (not "average) wages and credit availability.

Christopher Wright31/10/2010 12:25

Anyone budgeting for purchasing a house should not rule out the possibility of house price rises. We have a massive government deficit that has artifically increased demand and there has been the printing of money (called QE) which has been stoking up inflation . This has been accompanied by unrealistically low interest rates. Of course someone who makes his money be advising on mortgages will tell you that there is no interest rate risk.

david barker27/08/2010 19:36

I feel sorry for your lack of understanding the economy and probably as it is your lively hood you have to be positive.
You fail to point out that the Government is going to owe some thing upwards of 1.3 trillion pounds. This is more than at anytime in our history since the war. If the markets get one sniff of failure we will go into the most munumental tailspin you have ever seen. Forget our currency devaluing of 20% over the last 2 years and think more like 40%
For every 35p in the pound we spend in this country comes from imported goods. I assume you understand what happens to inflation when this happens... yes thats right it starts climbing very rapidly. Now if you think 8% is pie in the sky the markets will see this as LOW and we could see double figures.
Do you really believe that with figures being produced today (construction being the biggest) of record 1.2 growth since 2001 that inflation will stay in control
I think that you will see massive falls in the housing market when this happens

Ian27/08/2010 13:58

Boom and bust is the roller coaster. What's coming is a ride into hell.

Good news though, the economy is booming faster than any time since 1963 because of the last minute vote buying of the outgoing labour government.
Great! As we all know debt makes your economy healthy!

Emily27/08/2010 13:31

If you cannot see the possibility that interest rates in the UK can go up to 8% in the very near future you have absolutely no right to be commenting on the state of the housing market. Interest rates are ultimately set by the markets, not by the BoE, and 8% (yes 300% higher than current levels but why this is relevent I do not know) is not even that big a figure in historical terms. This article, although extreme, highlights the likely impact of the continued, not-on-my-watch, attitude that dominates financial management in this day and age. Now of course no-one WANTS rates to be up here, in the same way no-one WANTS to sell their house 50% lower than what they paid for it but if we have overly borrowed, and cannot afford to repay, the inevitable result of this is higher rates in the future. Long-term failure of the BoE to match rates to the fiscal position of the country will see the currency collapse, global debt markets become closed to UK PLC and rampant inflation as the cost of imported goods soars due to Sterlings collapse. Do you really think then the BoE would keep rates low just so your credit-induced property boom can be continued? You sir are believing your own hype and are sadly disillusioned!

Steve27/08/2010 07:55

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