The Bank's rate dilemma

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By Hugh Pym Economics editor, BBC News

Bank of England governor Mervyn King has much to ponder

Between a rock and a hard place - the Bank of England's predicament as described by increasing numbers of pundits around the City of London.

And it's an uncomfortable position as the Bank opts for a third successive hold on 5% rates at its latest monthly meeting.

The rock is inflation, well above the Bank's 2% target, now at 3.3% (by the CPI measure) and set to head above 4% later this year.

The hard place is the looming possibility of recession with all that means for jobs and economic output.

The Bank's remit is to keep inflation to its target range and to set policy accordingly. With that in mind a cut in interest rates would have been difficult to justify.

We won't get the minutes of the latest MPC meeting till Wednesday 23 July... it will make interesting reading

The bank's governor, Mervyn King, has expressed his concerns about a wage/price spiral developing with above inflation pay settlements forcing up prices.

He and his eight colleagues on the Monetary Policy Committee (MPC) will need time to assure themselves that the surge in international food and oil prices has not generated this sort of "second round effect".

Three-way split?

But the nagging worry for the MPC is that the evidence of a slowdown seen in recent weeks points to something worse, namely a steep contraction in growth in the second half of this year.

Business sentiment has soured in recent weeks. Expressions like "fallen off a cliff" have been heard in relation to orders and sales, and not just in the housebuilding industry.

The Bank of England has made it clear that a growth slowdown and squeeze on living standards is the price that will have to be paid if inflation is to be forced back into the bottle.

A slowdown is one thing but a prolonged period of negative growth is not part of the Bank's game plan. Such an outcome would bring inflation down with a bump, quite possibly requiring a letter to the chancellor explaining why it was too far below target.

Professor David Blanchflower has hitherto been the one member of the MPC consistently calling for lower rates. For him, a housing and consumer slump in line with the US is the biggest risk to the British economy.

But several of his colleagues have admitted to considering the case for higher interest rates because of the inflationary threat.

We won't get the minutes of the latest MPC meeting till Wednesday 23 July. It will make interesting reading. There could have been a three-way split between rate cutters, holders and raisers. Feathers could have been flying in a clash between hawks and doves.

Predicting an MPC meeting vote is an entertaining parlour game. But it's not so much fun when the stakes for the economy are so high.