UK Interest Rates Will Hit 2.6% By 2017, says E&Y

The Bank of England will hike its base interest rate from its record low to 2.6% within three years, according to a leading forecaster.

Ernst & Young (EY), the accountancy and services giant, said in its Spring 2014 Item Club forecasts that the BoE base rate will rise to 0.7% in 2015 before hitting 1.6% in 2016 and spiking again to 2.6% in 2017.

It is currently at its record-low of 0.5% as part of the Bank's ultra-loose monetary policy to keep markets liquid and the cost of credit down, therefore boosting the economy by supporting lending to businesses and consumers.

There are concerns that raising interest rates too quickly will choke off the UK's economic recovery, which estimates from the International Monetary Fund suggest (IMF) will see GDP grow faster than any other Western state in 2014.

Moreover, mortgage lending is on the rise again off the back of cheap credit made available through the Help to Buy and Funding for Lending schemes.

These mortgages are being taken out at a time of low interest rates, leaving borrowers exposed to higher repayment costs when the Bank of England lifts its base rate – and runs the risk of a wave of defaults.

But EY thinks it is London that will faces the biggest threat from interest rate rises because house prices in the city have soared.

According to Nationwide, the average house price in London leapt by 18.2% between the first quarter in 2013 and a year later, to £362,699.

"Housing investment has recovered sharply, and the resulting rise in supply will help to keep a lid on price rises in most of the country," said Peter Spencer, chief economic adviser to the EY Item Club.

"However London remains a special case, where surging prices have pushed mortgage income multiples close to their pre-crisis peak.

"So it is vital that the Financial Conduct Authority (FCA) prevents income multiples from getting too stretched in London.

"If these controls are rigorously applied, this will eventually constrain London prices – and head off severe problems when interest rates rise."

Bank of England Governor Mark Carney said he will not risk the UK's recovery by hiking interest rates because it is neither balanced nor sustainable.