Inflation and housing woe give Mervyn dilemma on interest rates

The Bank and its Governor Mervyn King are desperate to bring inflation back under control in the face of rising fuel and food prices with hawks considering an increase in rates. Doves are more concerned about the sharp slowdown in economic growth and the growing threat of a stagflationary recession. The Bank cut rates three times between December and April to 5% but has been on hold since.

Economists reckon it will leave rates unchanged again on Thursday as it weighs up the twin threats to the economy of inflation and slowing growth. Voting patterns will be heavily scrutinised when the minutes of the meeting are published later this month - with particular attention given to Spencer Dale, a new member of the monetary policy committee. The City wants to know whether he is a hawk or a dove.

The two-day meeting, which kicks off on Wednesday deep in Threadneedle Street, will be a lively affair with the MPC discussing these major issues:

INFLATION
The main objective of the Bank of England is to keep inflation under control - at the 2% target set by the Government-Inflation is currently runningat a heady 3.3% and looks set to rise above 4% in the coming months driven by rising fuel and food prices. This is a major concern to the Bank and its Governor, the self-confessed "inflation nutter" whose voting style is often seen as hawkish.

King was last month forced to write a letter to the Chancellor to explain why inflation was so far above target. With inflation rising, the MPC will seriously consider raising rates to bring it back under control. In the letter, King told Alistair Darling: "The MPC remains determined to set interest rates at the level required to bring inflation back to the 2% target."

UNEMPLOYMENT
Unemployment numbers are relatively steady, but there's no doubt which direction they are travelling. In the three months to April, the most recent figures, the jobless figures rose by 38,000 to 1.64 million. That took the unemployment rate up by

0.1% to 5.3%, which is not awful, but is enough to make workers nervous.

This may explain why employees have been willing to accept lower pay increases. Average earnings rose 3.8% in the year to February, down from 4% previously. Lower City bonuses are reflected in those figures, but they also indicate lower pay rises across the board.

John Philpott of the Chartered Institute of Personnel and Development says: "Employers are still hiring and there is still no sign of a widespread increase in the firing rate." There are nearly 30 million Britons in work - the highest number on record.

GDP
The economy grew at an impressive 3% last year but has slowed sharply since the credit crunch. Independent forecasters warn it will grow by around 1.5% this year and less than 1% next year with many predicting a recession - technically defined as two successive quarters of negative growth. Growth fell to 0.3% in the first quarter of 2008.

King recently warned a recession was "quite possible" and is well aware that alongside controlling inflation, the Bank must encourage long-term stability in the economy. The slowdown has been seized upon by doves who want a rate cut to breathe new life into the economy.

HOUSING
Nearly 2000 job losses at two of Britain's biggest housebuilders - Taylor Wimpey and Barratt Developments - is raw enough data for the MPC to consider when it judges the state of the housing market. Taylor Wimpey itself admitted that reservations have been running 60% down year on year and cancellations-have jumped 50%. Completions are down by a third and sales prices have fallen 8%.

Housing data from Britain's biggest building society, the Nationwide shows that prices are falling at their fastest rate since the crash of the early 1990s. Eight consecutive months of falls means prices are down 6.3% this year alone and 7.3% from the October peak. The Bank's own data shows that mortgage approvals have slumped by two thirds. But how bothered will be the Bank, which had been looking for this correction? After all, house prices are still 4% higher than two years ago and 9% higher than in 2005.

SPENDING
Households are being squeezed by rising fuel, food and mortgages - with retailersas diverse as Marks & Spencer and Carpetright reporting poor sales as a result.

The Bank of England says that creditcard borrowing in May was at its highest for two and a half years. Moneysupermarket.com claims four million people have used their credit cards to service loan or mortgage payments in the last 12 months.

It is likely to get worse, with homeowners facing having to remortgage at higher rates when their cheap existing deals expire.

Jason Gordon, director of retail at Ernst & Young, said: "Many UK consumer segments are clearly feeling the pinch as big rises in household costs are far outstripping relatively modest wage inflation."

In this climate, it may be no wonder that a poll of 72 economists by Reuters showed all think rates will stay at 5% this week. Howard Archer of Global Insight said: "The MPC seems set to keep interest rates unchanged. However, this could well mask a three-way split in the vote and the future path of interest rates is currently highly uncertain.

"The Bank is facing by far the most challenging economic environment since it was granted operational independence in 1997. Indeed, it is facing the most challenging environment since the early 1990s, if not earlier."