Interest rates expected to remain low until 2014

According to a leading economic forecaster, the Bank of England will need to keep interest rates at their record low until 2014.

The Ernst & Young Item Club, which bases its forecasts on the Treasury's own model of the economy, said the 0.5% base rate – currently at its lowest point in history remaining unchanged since March 2009 - must be kept low in order to counter-balance government's spending cuts.

Item believes that "high quality" economy growth will start in 2013 - led by business investment and exports.

Professor Peter Spencer from the Item Club said: "A base rate of 0.5% will begin to look like the new normal."

The Office for Budget Responsibility (OBR) has suggested that rates will begin to rise in 2011.

"The new coalition's plans to cut the deficit are certainly ambitious," Prof Spencer added.

"On the assumption that the government is able to implement the overall reduction of £40bn set out in the Budget, we expect that UK growth will struggle to reach 1% this year but will gradually speed up in the following years to give the UK a high-quality recovery based on trade and investment."

The Item Club expects the Consumer Prices Index (CPI) measure of inflation will continue to sit above the Bank of England's 2% target over the next 18 months, helped by high energy prices and VAT increases.

But it added that inflation will then fall "well below 2% as these effects wear off and spare capacity bears down on pricing decisions and wage bargaining".

"To prevent CPI inflation moving below 1% it will be necessary keep the Bank base rate low at 0.5% for much longer than the OBR and the markets have anticipated," Item said.

The Club said it expected to see growth slow over the next two years as a result of the government's package of spending cuts and tax hikes, but this will ultimately make the recovery more sustainable.

Rejecting dissenting economists' fears that implementing too many cuts in a short space of time could cause the UK to fall back into recession. The forecasting group believes the coalition's fiscal tightening "should not choke off the recovery".

The latest monthly survey from the British Chambers of Commerce showed a clear majority of businesses the emergency budget that took place last month struck the right balance between spending cuts and tax rises.

According to official data released last week, the UK economy grew at its fastest pace in four years, and twice as fast as expected, in the second quarter.

This is not the news that savers had hoped for, as interest rates on savings accounts remains low. Many savers are continuing to struggle in the battle to keep their rates higher than inflation, while taking income tax into consideration.

Many savers are now turning to fixed rate bonds in an effort to keep rates high. Predictions that rates will remain low have encouraged many frugal savers to fix the highest rate possible for several years to come using fixed rate bonds.