Will interest rates go up, up and away?

PEOPLE on their second or third homes will remember it well. Between 1988 and 1990, Chancellors Nigel Lawson, John Major and Norman Lamont doubled interest rates and threw the 1980s prosperity machine into shocking reverse.

That magical property wealth vanished or turned negative. Many homes could not be given away. Some homeowners, faced with huge monthly bills, simply gave up and dropped their door keys through the building society letterbox.

Could this happen again? No one is panicking yet, but some have become anxious following last week's news that Bank of England governor Mervyn King and his monetary policy committee are looking to start raising interest rates, probably from next month. The money markets predict interest rates will rise from 3.5% today to 5% by late next year.

The good news is that such predictions are probably wrong. Merrill Lynch analyst Andrew Roberts says: 'It doesn't mean the Bank is going to go gang-buster on the rate-raising path, unless the global economic recovery becomes entrenched and Europe and the US start hiking rates as well.' Many analysts see rates reaching no higher than 4.5% in 18 months.

Douglas McWilliams, at City think-tank CEBR, notes inflation is already falling. Under the new HICP measure it is just 1.4%, and the Bank of England may face a challenge raising it to the 2% target. 'It may even have to reduce rates next year,' says McWilliams.

But further rate rises remain a possibility - and the results could be calamitous. House prices and household debts are higher - even in relation to our higher earnings -than they were in the 1980s. Debt has risen 80% in six years. This leaves Britain more sensitive to interest rates than ever before.

An analysis by HSBC argues that interest rates of 5% would have the same impact on households as 10% rates did 10 years ago, when debts were much lower. Raising rates to 8% now would make monthly mortgage bills as unmanageable as they were at the early 1990s peak when rates hit 15%.

HSBC's calculations are based on total mortgage costs, including interest bills and capital repayments, in relation to income. A return to Norman Lamont-style misery is not as implausible as it may seem.

This comes as real after-tax wages are falling, and full-time jobs are starting to be replaced by 'self-employment' - often a euphemism for unemployment. London is awash with white-collar 'consultants'. And as HSBC economist John Butler notes, rising rates contain a trap. By slowing down the consumer, they would put pressure on exporters to take up the running in the economy.

But they would simultaneously hamper those exporters by pushing up the pound.

As ever, the best personal strategy is to cut your debts. If the worst happens, the costs of too much borrowing far outweigh the potential benefits.

Cheap loan stampede

HOME buyers are expected to pile into fixed-rate mortgage deals in a bid to shield themselves from the anticipated rise in interest rates.

But they may need to act fast. Nationwide Building Society on Monday raised interest charges on its fixed-rate mortgages by 0.2% because of its own higher borrowing costs. Nationwide will charge 4.79% fixed interest for two years, 5.09% for three years, and 5.29% for five.

Fixed-rate repayments lock borrowers into the same rate for on average two or three years. They account for 55% of all home lending, up from 22% a year ago.

Housing experts say newer loans that cap interest rates or offset savings against mortgage debt could also sell well.

The rush for fixed rates comes as housing experts warn that banks are already preparing for an increase in the cost of money.

Housing expert John Wriglesworth, at website Hometrack,

said: 'Fixed-rate deals are already reflecting the expectation of an interest rate rise.'

Mortgage lender Halifax acknowledged that its own rates are on the way up, adding: 'The days of the cheapest mortgage deals have definitely passed.'

But Wriglesworth said even a rate rise of 2% would have a 'trivial' effect on the housing market. 'Rates are still a third of what they were in the 1990s. Even with a rise, you're still talking about rates of less than half the longer-term average. A rise is not going to be helpful, but it will most certainly not send the housing market into a nosedive,' he said.

Despite fears of a rate rise, last month saw a huge £16.9bn of new mortgage lending, up £5.5bn on last year, according to the British Bankers' Association, which said overall demand for loans would remain 'buoyant'.