Interest rates 'will have to rise sixfold in two years'

“Many households have been benefiting (from the low interest rates) in terms of mortgage payments, but that will start to turn over the next couple of years,” said Lai Wah Co, the CBI’s head of economic analysis

The organisation predicts that the Consumer Prices Index, the Government’s preferred measure of inflation, will reach 3.8 per cent within the first three months of next year and that it will still be well above the Bank’s 2 per cent target two years from now. It currently stands at 3.3 per cent.

The CBI expects interest rates to climb from their record low level of just 0.5 per cent in the second quarter next year.

It forecasts rates will rise 0.25 percentage points each quarter before the pace doubles in the middle of 2012 to 0.5 point increases, taking the bank rate to 2.75 per cent by that year’s end.

Last week, the Bank of England warned in its Financial Stability Report that two thirds of borrowers are now on floating interest rate deals and the proportion is rising. At the height of the credit crisis in 2007, the proportion stood at less than half of all outstanding mortgages.

A 2.25 per cent rise in mortgage rates would see the monthly repayments on a typical £150,000 mortgage increase from £909 to £1096.

In another blow for home owners, economists predict that the average value of a home in Britain will lose 10 per cent of its value from their peak levels earlier this year to the end of 2011.

The house price gains seen at the beginning of this year have already been wiped out, according to Nationwide.

Britain’s biggest building society said the average price of a home dropped 0.3 per cent in November, the equivalent of almost £1,000 in a month, bringing the average price of a home to £163,398.

The CBI expects inflation as measured by the retail prices index – which includes more housing costs – will follow an even higher path than CPI, reaching 5 per cent at the start of next year.

The CBI said it had raised its quarterly forecasts to take into account the “persistent strength” of energy and commodity prices.

High inflation will put further pressure on households as people face higher prices and mortgage rates, but pay packets struggle to keep pace.

Tim Moore, an economist at research group Markit, said: “December brings to a close another difficult year for household finances. The UK economy looks to have avoided a double-dip recession in 2010, but there is little evidence that household finances have even begun to recover. People have seen their spending power gradually eroded by stubbornly high inflation throughout the year and little in the way of income growth to compensate for this.”